Who Spiked the Punch Bowl with Volatility

Happy New Year! No, that throbbing in your head is not because someone spiked the punch bowl at the annual holiday party. Rather, the markets have been spiked with volatility. The VIX and MOVE indices – volatility measures for equity and Treasury markets, respectively – increased about 10 points each last week (see charts below). Market participants are pointing to extreme Chinese stock market volatility and instability in the value of the Chinese currency, the renminbi, as the main reasons for the financial market gyrations. The Chinese Shanghai Composite Index fell nearly 10% last week, which triggered market circuit breakers and caused Chinese authorities to step in and buy stocks at least twice. The renminbi volatility is also in focus, because it is a mechanism through which investors can express rising fears about the health of the Chinese economy. China is a driver of global economic activity, and its impact on Southeast Asian and commodity exporting economies is material. Chinese market gyrations caused the worst S&P 500 New Year openings of all time with the index down ~6% on the week. But, while stocks started out the year rocky, the bond market has been much tamer. Looking back over the last year, this week’s volatility is nothing like what we experienced last August and September. The credit spreads in various investment grade bond sectors such as MBS, corporates and taxable municipals have held in very well (see “Spread” chart below). The marginal increase in volatility is actually benefiting tax exempt municipal bonds. Municipal to Treasury ratios are at their richest level in five years. It is important to remember that volatility is common in both the equity and fixed income markets, and that when volatility spikes, it is best not to panic. Should the equity market volatility spill over into the bond market, you can bet that we’ll be looking for ways to take advantage. 

Sources: Bloomberg, Financial Times, NY Times and SNWAM Research