Q&A: On the MOVE—what does this bond volatility index tell us?

02-07-2017

Most investors keep an eye on the Chicago Board Options Exchange’s Market Volatility Index (VIX), which tracks the volatility in the S&P 500. But there is another “fear” index that deserves watching: the Merrill Lynch Option Volatility Estimate Index (MOVE). It is essentially VIX for bonds, charting the implied volatility of 1-month Treasury options. While the VIX is currently low, even with recent political developments, MOVE is still close to its 5-year average and far above its all-time low reached in May 2013. We asked portfolio manager Chris Wu to shed light on the situation.

Q: What does the MOVE index seek to show? The MOVE index is a useful, market-based measure of uncertainty about the future course of interest rates. Higher values of MOVE indicate times when traders are willing to pay more for protection against unexpected movements in rates. The taper tantrum of 2013 is a good example. The index more than doubled in a short period of time when markets became especially uncertain about prospects for monetary policy. But in last few years, interest-rate volatility has been relatively low due to many global factors, including minimal investor concern about inflation, relatively low uncertainty about the likely future course of rates, strong demand for safe, liquid assets and somewhat stable macroeconomic growth.

Q: How does the MOVE index typically respond in a rising-rate environment? Interest-rate volatility can be an indicator of uncertainty and fear, therefore MOVE can jump higher in either a rising- or falling-rate environment. It certainly did so during both the 2008-09 financial crisis and the European debt crisis when rates dropped, but it also increased as interest rates rapidly rose following the election of Donald Trump in November. Uncertainty, whether about inflation, the near-term outlook for the economy or monetary policy, raises the riskiness of bonds. Term premium, the extra return lenders demand to hold a longer-term bond instead of investing in a series of short-term securities, usually rises in situations like this. Research suggests that the MOVE index and bond term premia shift together, consistent with the idea that uncertainty and risk raise term premia.

Q: What is the current MOVE’s level telling us? The MOVE index is certainly higher than it was pre-election, but it has come down in recent weeks. In the second half of 2016, the market began to question the efficacy of loose monetary policy. The potential for a shift from monetary to fiscal expansion combined with less central-bank accommodation, could disrupt the prevalent low interest rate/low volatility paradigm. Political developments on both sides of the Atlantic and other unknowns have significantly increased the odds of “boom” or “bust.” And while the Federal Reserve (Fed) has communicated it could raise short-term interest rates “a few times” this year and next—and it more likely will do so if inflation significantly picks up due to Trump’s actions—the eventual path for monetary policy is highly uncertain. It seems to be in a wait-and-see mode. All of this should translate into structurally higher rate volatility going forward.  While many market participants, including us, expect higher yields by the end of this year and perhaps over the next couple years, the path getting there could be bumpy.

Thank you, Chris.