As optimism grows over a potential peace agreement between the U.S. and Iran, the U.S. Treasury market has recently regained its calm. However, a growing number of Wall Street institutions are warning that this low-volatility environment may not be stable.
Recently, volatility indicators in the U.S. Treasury market have retreated to their lowest levels this year, nearly erasing the market panic previously triggered by the Middle East conflict and surging oil prices. Meanwhile, the yield on the 30-year U.S. Treasury has also retreated significantly from its near-19-year highs. Earlier, U.S.-Iran tensions had pushed up energy prices and sparked concerns about re-inflation and renewed Federal Reserve rate hikes, leading to a sharp sell-off in the Treasury market. However, as markets have recently begun betting on a potential peace deal between the two sides, Treasury yields have gradually declined, and market sentiment has noticeably stabilized.
Nevertheless, a team of strategists at Morgan Stanley believes that the market's current expectation of "sustained calm" may be underestimating potential future risks. In a recent report, strategists including Shaun Zhou stated that factors such as renewed shocks in the energy market and escalating geopolitical conflicts could still quickly reignite volatility in long-term interest rates. The report noted, "The market is currently in a clearly asymmetric situation; relatively small macro catalysts could lead to a significant repricing of uncertainty in long-term rates."
In fact, some large traders have already begun positioning ahead. Last week, a "long volatility" trade with a premium of up to $15 million appeared in the U.S. Treasury options market, betting that the market will experience sharp fluctuations again in the future. At the same time, there has been a surge in "straddle" and "strangle" option strategy trades recently. These strategies are typically used to bet on significant future volatility in the underlying asset without specifying a direction.
Analysts point out that this means an increasing amount of capital is becoming concerned that the current low-volatility state in the Treasury market may be difficult to sustain. However, not all investors believe volatility will rise again. On Tuesday, a significant number of "short straddle" trades also appeared in the market, betting that interest rate volatility will continue to decline in the future. This strategy implies that as long as Treasury prices remain relatively stable, sellers can earn premium income. However, if the market experiences sharp fluctuations again, these positions could quickly incur significant losses.
Morgan Stanley explicitly warned that the current macro environment remains "fragile." The bank noted that several factors currently suppressing market volatility may weaken simultaneously in the future, and the extremely low implied volatility suggests that the market may be significantly underpricing risks.
Beyond the derivatives market, the spot Treasury market has also recently seen a resurgence of bullish sentiment. According to the latest JPMorgan client survey, as of the week ending May 26, investors' net long positions had risen to a one-month high. Data shows that investors' long positions increased by 5 percentage points, while short positions decreased by 2 percentage points.
Meanwhile, the SOFR (Secured Overnight Financing Rate) options market has also seen a surge in new bets recently. A significant number of new positions have accumulated around the 96.5 strike price, indicating that the market is actively positioning for future changes in the interest rate path.
Analysts point out that the core market contradiction lies in the fact that, on one hand, the easing Middle East tensions have stabilized market sentiment in the short term. On the other hand, uncertainties surrounding inflation, energy prices, and the Federal Reserve's policy path remain sufficient to reignite significant volatility in the long-term Treasury market. Wall Street fears that the current market "calm" may only be a brief window before the next major wave of volatility.
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