(Bloomberg) -- As hopes for a lasting deal between the US and Iran steady markets worldwide, traders are tentatively reviving a range of bets that benefit from falling volatility.
Key gauges of bond, currency and equity swings have declined almost every day since late March, as optimism has grown that the US and Iran are moving toward a agreement to end a month-long conflict that triggered the biggest oil disruption in history.
On Thursday, a measure of US rates volatility ticked slightly lower to trade near levels last seen before the start of the Middle East conflict, and US 10-year yields held at 4.28%. Activity in Treasury futures remained well below usual levels, with volumes at just 50% of recent averages as of 9 a.m. in New York. Meanwhile, US stocks, having erased all of their war-related losses, paused early Thursday after notching fresh records a day earlier.
Calmer markets encourage strategies that generate steady income — or carry — over time, even if underlying currencies or bonds don't move. In foreign exchange, a gauge of returns on such trades — where investors borrow in low-yielding currencies to invest in higher-yielding ones — has climbed to record highs.
In the bond market, wagers that Treasuries will outperform interest-rate swaps — a popular hedge fund trade that tends to do well in low-volatility environments — have been profitable since the end of March. Interest-rate strategists at
Investors will "look for positive-carry trades," said John Briggs, head of US rates strategy at Natixis SA. He cautioned, though, that such positions are likely modest in size, as "headlines can quickly shift the narrative."
In recent days, standout trades in the bond options market have included wagers on yields to keep trending lower as well as short positions designed to profit from falling volatility. On Wednesday, one of these trades was a $10 million sale of so-called strangles, which would benefit from the current low volatility backdrop extending over the coming weeks.
Of course, betting on falling volatility these days is risky. Tensions remain elevated around the Strait of Hormuz, even as the US and Iran are considering extending their ceasefire to allow more time to negotiate a deal. The US began a blockade of ships leaving or entering Iranian ports on Monday, which Iran has criticized and signaled may amount to a breach of the ceasefire that agreed on April 7. Oil prices, while down from their highs, are still well above pre-war levels.
"I don't think outright short-vol trades are necessarily the right ones, given the y backdrop, but that's where the market is heading," said Jan Nevruzi, an interest-rate strategist at TD Securities.
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"Moderate growth and stable policy backdrops are typically environments in which carry strategies can prosper," strategists including George Cole and William Marshall wrote in an April 14 note.
--With assistance from Carter Johnson.
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