Stock bulls, forget about 3% yield. Rate volatility is falling

What level of bond yields spells trouble for equities? 3%, 3.5% or 4%? The answer may be less about the levels per se, but more about the volatility of the rate changes. While 10-year yields are approaching 3%, volatility is gradually cooling, which should be encouraging for stock investors.

Rising yields themselves are not necessarily bad for stocks if they reflect optimism about growth. After all, during the last stock bull market between 2003-2007, 10-year yields went from about 3% to above 5%. But how yields rise matters. Rising volatility typically indicates uncertainty about inflation, growth and fiscal dynamics. Higher rate volatility should add to the risk premium in equities.

Since 1988, whenever Bank of America's MOVE Index for bond volatility increased 10 points over four weeks, the S&P 500 lost an average of 1.2% during the same period. However, when the yields rise in either 10s or 2s, the S&P had positive returns.

Of course, if bonds surge to 4% next month, all bets are off. But rising yields with falling volatility is perhaps not a nightmare for stock investors after all.

Source: Bloomberg Pro Terminal

Jr Trader Alexander Kumanov

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