Yield volatility on 10-year bunds has climbed to nine-times its average during the past 15 years, giving traders a taste of the turbulence European Central Bank President Mario Draghi said June 3 they should get used to as the byproduct of record monetary stimulus.

A measure of 30-day volatility on bunds surged to 300 percent in May. It hadn’t gone above 100 before this year, in data compiled by Bloomberg going back to the middle of 2005. The market’s gyrations are being magnified by record-low yields: In the week of Draghi’s remarks, yields soared 0.36 percentage point, the biggest jump since 1998. The yield was at 0.82 percent on Monday at 6:19 a.m. in New York, up from a record of 0.049 percent on April 17.

“Investors should be pricing in more risk,” said Grant Peterkin, a money manager at Lombard Odier Investment Managers, which oversees 161 billion Swiss francs ($172 billion). “Given bonds steadily rallied for a long period of time, the low volatility suggested they were low risk, which potentially forced investors to buy more of them.”

The danger is that this kind of instability may seep into other assets, he said. This could pressure companies as well as governments with rising borrowing costs. Yields on junk bonds around the world have collapsed to about 6.6 percent, versus their average of 9.7 percent since the end of 1997, according to Bank of America Merrill Lynch index data.

Eoin Treacy's view

There is so much uncertainty surrounding Greece’s negotiations with its creditors that volatility has increased. Little wonder since this was not a situation anyone planned for when the Euro was set up and no one really knows how it will end. Considering the legacy of Argentina’s default, the potential for a long drawn out saga would appear to offer a template in the event Greece does not accede to remands for additional concessions. 

The uptick in volatility is an issue for bond investors who have previously been treated to one of the least volatile environments in history. At The Chart Seminar we work through the following through experiment: Ask yourself “When is a winning strategy questioned in your organisation?” When everything is going well, the only questions people ask are about how to enhance whatever the strategy is to generate even more profits. Whoever is doing best is held up by management as the example everyone should follow. Very few question the basis for the strategy, particularly if it has been in place beyond the short term, until it stops working. 

It is not until a strategy is seen to stop working that questions about its validity begin to arise. If management has been following a high-leverage-long strategy predicated on low volatility, the recent move means that position sizes have to decrease which exacerbates the move. The question then is where will the new buyers come from when large players have been forced to reassess the size of their positions given new risk parameters? 

This suggests the lows are in for Bund yields. A sustained move below 0.5% would be required to begin to question potential for additional higher to lateral ranging. As a result of the move in Germany’s benchmark, sovereign spreads across the Eurozone are unlikely to get back to where they were only a month ago.     

Italian spreads, for example, have rallied back to test the more than two-year progression of lower rally highs. A sustained move above 150 basis points would suggest a return to supply dominance beyond the short term. Such an eventuality would probably result in the ECB taking additional measures to provide liquidity. 

Blackrock has found support in the region of the 200-day MA on successive occasions since 2012 and will need to hold the $350 if potential for additional higher to lateral ranging is to be given the benefit of the doubt.