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Bond sell-off sparks return of volatility

Bond sell-off sparks return of volatility

This week’s sell-off in bonds has precipitated a return of volatility to stock markets as rising yields (which move inversely with prices) prompt investors to reconsider equity valuations. Higher US Treasury yields mean the assumption of forward cash flows has to increase, or the price of stocks has to fall, to imply the risk premium for holding equities will be maintained.

This creates greater scope for disagreement on asset valuations than in the quantitative easing (QE) era and the new uncertainty ends the low volatility environment in asset markets. A dramatic spike in the Chicago Board of Exchange VIX index – which measures implied volatility from the rate of price changes on S&P 500 index options – caught out traders who were using instruments such as leveraged exchange traded funds (ETFs) to short volatility.

More broadly, as the dust settles on this week’s market moves, some analysts expect to see more divergence in asset allocation strategies going forward. Wei Li, head of Investment Strategy, Blackrock iShares EMEA, explains the stock market pull-backs as investors unwinding trades that had bet on low volatility continuing.  

Continued softness in the value of the dollar despite rising Treasury yields suggests expectations of further growth in the US are not especially high despite the prospect of reduced taxes. It is unsurprising that iShares should see the recent falls as an opportunity to buy on dips but, in keeping with a more reserved view of the US, they favour equities in the eurozone, Japan and emerging markets.

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