Volatility has ticked up across equity and credit markets this week as the reality of multiple risks on the horizon starts to sink in. It seems likely we are set for an increase in both implied and realised volatility in the final quarter of the year.
The volume of negative-yielding fixed income means that markets are in a precarious position, while the interest-rate sensitivity of credit has increased and is near the highest level in several decades (see figure 1).
Figure 1. Interest-rate sensitivity soars
ICE Bond Indices, as at October 2020.
Investors have been lulled into a false sense of security as central-bank activity has lowered expected interest-rate volatility (the Federal Reserve has followed in Japan’s footsteps and supported the market).
Yet the outcome of the upcoming presidential election will determine where interest rates go. Higher-than-expected stimulus following the election could exacerbate a sell-off in rates and surprise investors, particularly within the investment-grade market.
A mix of catalysts can move government-bond yields either way and investors should pay close attention to the duration exposure of their portfolios. The uptick in coronavirus cases, US election, the UK’s imminent exit from the European Union and Q3 earnings will all be in focus over the next few weeks.