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08 Sep 22 Insight Fixed Income Ardea Investment Management

Ardea Market Musings: From macro to micro: The implications of high volatility for interest rate relative value

  • We examine the link between high interest rate market volatility and relative value pricing relationships.
  • The current high macro volatility regime is having a greater than usual impact on micro relative value.
  • Stress in micro interest rate relative value is at extreme levels, improving future opportunities in this segment of the market.

Global fixed income markets have experienced a massive correction this year. Aggressive central bank rate hikes, surging inflation and weaker global growth have driven double-digit losses for duration and credit heavy portfolios. In the wake of this repricing, many investors see the outlook improving alongside cheaper valuations. There are merits to this view, but also many reasons to remain cautious.

Interest rate Relative Value (RV) strategies avoid the duration and credit exposures that are the main drivers of the recent correction in conventional fixed income portfolios. Nonetheless, surging interest rate market volatility can spillover into interest rate RV. In this note, we outline the links between the current high volatility regime and RV. We show that RV pricing relationships are stretched to historically extreme and unsustainable levels. The current stress in interest rate markets improves the outlook for RV strategies.