The investment grade corporate bond spread, which recently fell to its lowest level since 1997, indicates that investors are sanguine about risk across asset markets.
This lack of concern is showing up in other measures of risk as well:
- Moody’s investment grade less 10-year yield, our preferred metric, stands at or near multidecade lows.
- The MOVE Index, which measures volatility in the Treasury bond market, is at multiyear lows.
- The CBOE VIX, which measures volatility in the stock market, has been muted recently, despite Friday’s late gain. In addition, out-of-the-money puts implied volatility for options on system overnight futures—hat tip to Bloomberg Fixed Income Strategist Ira Jersey—recently dropped to a three-year low.
All of these measures point to increasing complacency in financial markets despite the possibility of rising interest rates, changing trade and fiscal policies, and rising inflation.
Read more of RSM’s insights on the economy and the middle market.
In our estimation, this outlook rests upon a shaky foundation that assumes there will be no rate hikes over the horizon.
Yet inflation has reaccelerated recently, driven by sticky service sector pricing and stubborn housing costs. If this acceleration continues, creating the need for the Federal Reserve to raise its policy rate, investors are not well positioned for a rapid reversal that could take place in both bond prices and equities.
From our vantage point, the complacency creep is real and needs to be part of a realistic risk matrix whether one is a corporate manager or a professional investor.
