As we’ve seen in recent weeks, volatility has been on the rise across various asset classes. This week in particular has seen a resurgence of Iran-related volatility on both the downside and upside. While rates have been leading the cross-asset move on a volatility-normalized basis, implied volatilities for rates are still relatively low compared to other assets such as equities, FX, and commodities. However, there are growing concerns about inflation and growth that could potentially invert the relationship between back-end rates and spot prices.

For instance, the ATLT17Jul 90 (104.2%) call is currently offered at 1.16 (1.35%) versus the 86.385 spot reference price. This means that if yields were to revert to their 2024 lows of 4% on 20-year bonds, the investor would receive a payout of 8.5 times their net investment. While this may seem like a lucrative opportunity for investors, it’s important to consider the potential risks involved.

One major concern is the heightened volatility that we’ve seen across asset classes. As we’ve discussed in previous posts, increased volatility can lead to a greater likelihood of contagion effects, where the performance of one asset class can have a ripple effect on other assets. This could potentially result in a more pronounced downturn in the market if investors begin to panic and sell off their positions en masse.

Another concern is the potential for inflation to rise. As we’ve seen in recent months, inflation has been ticking upwards, which could lead to higher yields on longer-term bonds. While this may seem like a positive development for investors, it can also lead to increased uncertainty and risk aversion among market participants.