Volatility and Rates: Past as Prologue?

Written by: Global Thought Leadership | December 15, 2017

Source: Bloomberg and Legg Mason,12/1/17. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

The Bottom Line

  • The yield curve got some well-deserved attention at the press conference following the Dec 13th rate hike by the Fed, as Chair Janet Yellen explained why the FOMC believes recent shifts aren’t a harbinger of recession.
  • In particular, she focused on the spread between 2-year and 10-year rates – a key part of the yield curve in measuring the transition between short- and long-term rates. But that spread may also be sending a signal about future stock market volatility.
  • Recent history suggests that a decline in the spread between 2- and 10-year Treasuries has been a look-ahead signal – by a little less than three years – of a notable rise in stock market volatility.
  • An historical pattern like this can’t predict the future, of course, but it does provide food for thought. There is a certain amount of logic here: if a flattening yield curve signals economic trouble ahead, it’s hardly surprising that stock market volatility would also ensue.
  • The lag could be a result of the time it takes for changing economic conditions to work their way through companies’ financial conditions to the point that earnings erode.
  • Whatever the explanation, this relationship highlights the historic lows of stock market volatility, and suggests that low volatility might not be the new normal after all.
  • The bottom line: investors could be well advised to consider the impact of future volatility on their own investment portfolios, and to consider investments specifically designed to soften the impact of market volatility while providing other characteristics, such as income.

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IMPORTANT INFORMATION: All investments involve risk, including loss of principal. Past performance is no guarantee of future results. An investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.

Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls. International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.

The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice.  Statements made in this material are not intended as buy or sell recommendations of any securities. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not  take into account the particular investment objectives, financial situation or needs of individual investors.