We’ve written previously about the traditional sources of excess return for fixed income active managers, one of which is taking on higher term or interest rate risk. 2024 witnessed a sharp reversal in the excess returns from term risk, as long duration tilts that would have rewarded managers in 2023 hurt them in 2024. A key reason for this reversal was the dramatic rise in long-term yields, one of the consequences of which has been a steepening of the U.S. Treasury yield curve.

As a result, all eyes have been on the 10-year U.S. Treasury yield, which has whipsawed over the past year, rising above 4.7% as of Jan. 8, 2025, reaching levels last seen in April 2024 and close to the peak from October 2023. The surge in yields leading into and following the U.S. presidential election has been driven by a myriad of factors including robust economic growth and inflation concerns, as well as the U.S. Federal Reserve’s hawkish signaling on Dec. 18, 2024, of fewer-than-expected rate cuts in 2025.

Related to duration or interest rate risk, one way we can assess bond market nervousness is through market expectations for long-dated U.S. Treasury volatility, as reflected by the options market with the Cboe 20+ Year Treasury Bond ETF Volatility Index (VXTLT). VXTLT movements have generally paralleled the rise in U.S. Treasury yields over the past couple of years, reaching a high above 22 on Oct. 31, 2024, ahead of the election. Exceptions included turbulent days, such as the unwind of the global carry trade on Aug. 5, 2024, when yields plunged as investors sought the safety of U.S. Treasuries and VXTLT spiked to over 20. The index has risen since early December 2024 to 17.51 as of Jan. 8, 2025, perhaps driven by market unease over the election results and associated tariff policies, the Fed’s future rate trajectory, as well as inflation.

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But how does the volatility of the bond market compare to that of the equity market? The first chart in Exhibit 2 shows that VXTLT levels typically have sat below those of the Cboe Volatility Index^® (VIX), a widely known measure of expected equity market volatility. However, while there was a small tick upward in 2024, the differential between the two has generally declined since 2020, as portrayed by the second chart in Exhibit 2, which calculates the ratio in VIX compared to VXTLT. Notable catalysts include uncertainty stemming from the pandemic and Fed rate hikes beginning in 2022 driving up bond implied volatility, coupled with relatively low equity implied volatility.

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Coming off a rollercoaster 2024, as we look ahead to the Fed’s January 2025 meeting and a new presidential regime, the future path of U.S. Treasury yields may have important implications for multi-asset and fixed income asset managers and asset owners when thinking about their risk profiles.

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