Subscribe to receive this FREE daily commentary directly in your email
The S&P 500 rose about 30 basis points on December 3rd, but today was a volatility-dispersion day, with the S&P 500 dispersion index rising. Not by much, but enough to highlight the dynamic of the index rising while implied correlations fell. We also saw index-level volatility decline, with the VIX down on the day, even as the VIX S&P 500 Constituent Index moved higher.
On the surface, it looked like a healthy rotation, with the MAG-7 lagging and the S&P 500 equal-weight index outperforming. But in reality, it was a day of MAG-7 underperformance and market participants trying to figure out how to nudge the overall index higher, amid bullish option flows beneath the surface.
According to the CBOE’s VIX decomposition tool, almost 2/3 of the VIX decline was due to the S&P 500 moving higher on the volatility curve, with the balance coming from volatility selling.
Despite the weak ADP report this morning, the 10-year Treasury rate fell only about three basis points and remains above 4%. It’s an interesting dynamic because rates have essentially been holding around 4% on the 10-year, which appears to be functioning as a floor. This likely comes down to the fact that the overall yield curve is still not steep enough. The spread between the 10-year and the 3-month Treasury bill is only about 34 basis points, and historically, this spread peaks around 350 basis points.
So even if the Fed eventually cuts rates back to the neutral level near 3%, the 10-year would have little incentive to fall further—because the spread would still only be around 1%. In theory, if the 10-year were to trade at a historically normal premium of 300 to 350 basis points above the 3-month Treasury, then the 10-year yield should be closer to 6% than 4%.
This likely explains why long-end rates aren’t falling as many expect. The market seems to be acknowledging that the yield curve is too flat, and that the Fed is unlikely to cut deeply enough to create the kind of spread widening needed to normalize the curve. In a sense, the market is signaling that the curve needs to steepen further, and that process may begin as we get closer to the Fed’s ultimate policy destination and the market gains greater clarity.
It’s interesting because, at the same time, we’re seeing interest-rate spreads between the U.S. 10-year and the Japanese 10-year contract to their tightest level since March 2022, yet the Japanese yen has weakened to 155. The divergence between the spread and the currency is now one of the widest we’ve seen in some time, and it points to one of two — or potentially three — possibilities.
First, the yen may need to strengthen materially against the dollar, potentially even falling below 140.
Second, the FX market may be indicating that the spread is unlikely to contract any further — meaning U.S. rates may need to rise again, widening the differential.
And third, Japan’s rates would have to collapse. But with the BOJ preparing to hike rates because Japan still has an inflation problem and fiscal stimulus increasing, it seems unlikely that Japanese rates are about to fall sharply.
That effectively narrows the scenario set to just two outcomes: either the yen strengthens significantly or U.S. rates move higher.
Given that the U.S. Treasury yield curve is also signaling that it is too narrow and needs to steepen further—most likely through higher long-end rates—it seems more likely than not that the divergence between the interest-rate differential and the Japanese yen reflects expectations for U.S. rates to rise. In other words, the FX market may be betting that U.S. yields still have further to climb, which would help reconcile why the yen has weakened even as the rate spread has compressed.
It’s something worth thinking about.
-Mike
Glossary by ChatGPT
ADP Report – A monthly employment estimate published by ADP that often serves as a precursor to official U.S. payroll data.
Basis Point – A unit equal to one-hundredth of a percentage point, commonly used to measure changes in interest rates or yields.
BoJ (Bank of Japan) – Japan’s central bank responsible for monetary policy, interest-rate decisions, and liquidity operations.
Dispersion Index – A measure of the variability of returns among index constituents, reflecting how differently stocks are moving relative to each other.
Equal-Weight Index – An index construction method where each constituent has the same weighting, regardless of market capitalization.
FX Market – The global marketplace for trading national currencies and currency pairs.
Implied Correlation – A measure derived from options pricing that reflects how much individual stocks are expected to move together.
MAG-7 – A group of seven large-cap U.S. technology-oriented stocks often viewed as major drivers of index performance.
Neutral Rate – The theoretical interest rate that neither stimulates nor restricts economic growth.
Spread (Yield Spread) – The difference between two interest rates or bond yields, typically reflecting relative risk or maturity characteristics.
Steepening (Yield Curve) – A change in the yield curve in which the difference between long-term and short-term interest rates increases.
VIX – A volatility index derived from S&P 500 options that measures market expectations for near-term equity volatility.
Volatility Selling – A strategy involving selling options or volatility products to profit from declining implied volatility.
Yield Curve – A graph showing the relationship between interest rates and bond maturities, often used to assess economic expectations.
Disclosure
This report contains independent commentary to be used for informational and educational purposes only. Michael Kramer is a member and investment adviser representative with Mott Capital Management. Mr. Kramer is not affiliated with this company and does not serve on the board of any related company that issued this stock. All opinions and analyses presented by Michael Kramer in this analysis or market report are solely Michael Kramer’s views. Readers should not treat any opinion, viewpoint, or prediction expressed by Michael Kramer as a specific solicitation or recommendation to buy or sell a particular security or follow a particular strategy. Michael Kramer’s analyses are based upon information and independent research that he considers reliable, but neither Michael Kramer nor Mott Capital Management guarantees its completeness or accuracy, and it should not be relied upon as such. Michael Kramer is not under any obligation to update or correct any information presented in his analyses. Mr. Kramer’s statements, guidance, and opinions are subject to change without notice. Past performance is not indicative of future results. Neither Michael Kramer nor Mott Capital Management guarantees any specific outcome or profit. You should be aware of the real risk of loss in following any strategy or investment commentary presented in this analysis. Strategies or investments discussed may fluctuate in price or value. Investments or strategies mentioned in this analysis may not be suitable for you. This material does not consider your particular investment objectives, financial situation, or needs and is not intended as a recommendation appropriate for you. You must make an independent decision regarding investments or strategies in this analysis. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Before acting on information in this analysis, you should consider whether it is suitable for your circumstances and strongly consider seeking advice from your own financial or investment adviser to determine the suitability of any investment.
Subscribe to receive this FREE daily commentary directly in your email
This report contains independent commentary to be used for informational and educational purposes only. Michael Kramer is a member and investment adviser representative with Mott Capital Management. Mr. Kramer is not affiliated with this company and does not serve on the board of any related company that issued this stock. All opinions and analyses presented by Michael Kramer in this analysis or market report are solely Michael Kramer’s views. Readers should not treat any opinion, viewpoint, or prediction expressed by Michael Kramer as a specific solicitation or recommendation to buy or sell a particular security or follow a particular strategy. Michael Kramer’s analyses are based upon information and independent research that he considers reliable, but neither Michael Kramer nor Mott Capital Management guarantees its completeness or accuracy, and it should not be relied upon as such. Michael Kramer is not under any obligation to update or correct any information presented in his analyses. Mr. Kramer’s statements, guidance, and opinions are subject to change without notice. Past performance is not indicative of future results. Neither Michael Kramer nor Mott Capital Management guarantees any specific outcome or profit. You should be aware of the real risk of loss in following any strategy or investment commentary presented in this analysis. Strategies or investments discussed may fluctuate in price or value. Investments or strategies mentioned in this analysis may not be suitable for you. This material does not consider your particular investment objectives, financial situation, or needs and is not intended as a recommendation appropriate for you. You must make an independent decision regarding investments or strategies in this analysis. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Before acting on information in this analysis, you should consider whether it is suitable for your circumstances and strongly consider seeking advice from your own financial or investment adviser to determine the suitability of any investment.
Market Dynamics Shift as 0DTE Drives Persistent Dispersion
Mott Capital's Market Chronicles 10 hours ago