As the yield curve continues to shift in a stagflationary direction, market participants are facing renewed challenges in navigating the complex landscape of risk assets. In this blog post, we will delve into the implications of the recent move lower in yields for equities and options, and how dealers are positioning themselves in these markets.

The yield curve has been a key focus area for investors and market participants in recent months, as the 10-year real yield has surged to 4.5% while the 30-year real yield is at 5%. While some may find it curious that the 10-year real yield has moved higher despite a relatively stable breakeven rate, it’s important to recognize that this shift is indicative of a stagflationary environment. As yields rise in such an environment, it can lead to increased stress in risk assets, including equities and options.

The recent move lower in yields has the potential to hit equities through the Risk Parity channel, as CTAs have cut equity risk to the ~25th percentile on QDS estimates. While this may seem counterintuitive, it’s important to recognize that a stagflationary environment can lead to increased volatility in both yields and equities. As such, Risk Parity leverage remains elevated, with potential for additional supply from macro systematic strategies totaling $30 to $35 billion over the next week. Moreover, if equities fall more than 1% or yields continue to rise, there could be further downside pressure on these risk assets.

In the options market, the Street is slightly short gamma at current levels, with the market free-er to move. While this short gamma will roll off next Tuesday, dealers are only slightly long option gamma then, and not enough to offset the levered ETF short gamma exposure of $7 billion/1%. This means that there could be increased volatility in options markets as well, which can have implications for risk assets.