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It was a rather uneventful day in the stock market, with the S&P virtually unchanged, up just about 10 basis points. I think today really demonstrates that without implied volatility to crush, the market has very little juice to it. The VIX was basically unchanged, closing around 15.80, while the VIX 1-Day was up only fractionally to 10.30.

Given where volatility currently stands, I wouldn’t expect to see much of a volatility crush tomorrow following the PCE report, if there is one at all. Additionally, there doesn’t seem to be much room for volatility to move lower, considering the 16 area has been fairly sticky from an options standpoint, and the VIX 1-Day doesn’t appear to have much room to fall from here. With a Fed meeting next week, one would expect implied volatility to start rising as we head into that event.
 

Because of the tight trading range over the past week, nine-day realized volatility has dropped to around 8.9%. Unless that range begins to expand, realized volatility is likely to continue contracting in the coming days. That said, any move in the index greater than about 55 basis points would likely cause realized volatility to start rising again. That’s something to watch closely, especially given where implied volatility currently sits. A pickup in realized volatility would put a floor under implied volatility and would likely cause implied volatility to rise as well.
 

The case for long-end rates moving higher also continues to build. Ten-year Treasury yields in the U.S. rose about four basis points on the day, climbing to 4.1%. We’re still watching to see whether the ten-year can push above the 4.16% area, which would allow it to break out toward roughly 4.3%. That would likely also confirm the inverse head-and-shoulders pattern that appears to be forming.

More importantly, the relative strength index has begun to move higher, suggesting that momentum behind rising Treasury yields is building. This is occurring despite expectations for Fed rate cuts. The move higher in long-end rates could reflect rising yields in Japan, growing market concern about a potential Fed policy mistake, or uncertainty around who the next Fed chair may be. There are several reasons why long-end rates could be rising that go beyond current economic conditions.
 

Meanwhile, interest rate differentials between U.S. Treasuries and JGBs continue to contract, with the spread on 10-year rates now down to just 2.16%. At some point, the divergence we’re seeing—between a weakening Japanese yen and narrowing rate spreads—is likely to put pressure on the yen to begin strengthening. The spread is getting awfully tight. Otherwise, it implies that U.S. rates may still have further to climb. Either way, something has to give here because the interest-rate spread and the currency move have been diverging for too long, and grown too wide.
 

It is important to note that the JPY 5-year forward rate appears to have formed a bull flag, suggesting that if the forward rate breaks out and rises — becoming less negative — the yen is likely to strengthen versus the dollar. A breakout from this pattern would imply further narrowing of the U.S.–Japan interest-rate differential and, based on current FX and forward rates, point to a USD/JPY rate of roughly 137.50.
 

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