Surprise, surprise. Contrary to conventional wisdom, the bond market may be taking its risk cues from equities. At least, that appears to be the case when fluctuations in the two major volatility indices are compared.
Equity investors often look to the CBOE Volatility Index (VIX) as a gauge of fear or future uncertainty in the stock market. Meanwhile, fixed-income investors rely on the Merrill Lynch Option Volatility Estimate (MOVE Index) to track expectations of future volatility in the bond market. But which market sets the tone for the other? Does one of these volatility measures lead the other, or are they simply reacting to distinct sources of risk within their own domains?
Challenging Assumptions: Evidence That Equities Lead Bond
To answer that question, we examined how the VIX and MOVE indices have interacted over time, using daily data going back to 2003.
Our analysis revealed a surprising result: while fluctuations in the MOVE index do not predict movements in the VIX, changes in the VIX do help forecast future moves in the MOVE index.
This flips conventional wisdom. Investors often assume that the bond market, with its sensitivity to interest rate expectations and macroeconomic signals, sets the tone for equities. But at least when it comes to market-implied future uncertainty, the relationship appears reversed: the bond market is taking its cues from stocks.
To explore this, we looked at how the two indices behave together. Over the last 20 years, they’ve generally moved in tandem, particularly during periods of macroeconomic stress, with a 30-day rolling correlation that averaged around 0.59. But correlation isn’t causation. To test for a predictive relationship, we used Granger causality analysis, which helps determine whether one time series improves forecasts of another. In our case, the answer was clear: the VIX leads.
Market Stress and Temporary Bond Leadership
Interestingly, the pattern shifts during periods of elevated stress. When both the VIX and MOVE indices spike above their 75th percentile levels, indicating a high-volatility period, we observe a reversal: the MOVE index shows some predictive power over the VIX. In these moments, equities appear to take cues from bonds. While rare, this exception suggests that in times of acute uncertainty, the usual flow of information between markets can briefly reverse.
One way to interpret these results is that because the MOVE index seems to take the lead during periods of extreme uncertainty, bond managers are more attune to huge macro shifts in the economy and capture big sentiment shifts better than equity managers (i.e., when we go from positive to negative momentum).
Implications for Multi-Asset and Hedging Strategies
These findings may have the most impact not for investors that invest solely in one asset, but more so for investors that are spread across various asset classes. The results highlight that for multi-asset managers, when it comes to assessing fear in the market, it may be best to pay attention to the bond market when big moves in fear or uncertainty become apparent. But when dealing with small movements in the perception of future uncertainty, the stock market may surprisingly be the better measure of risk to track.
These results also have strong implications for investors who are not in the equity market or the debt market, yet use them to hedge risk. If a commodities trader is looking for early signs of big moves in the equity market or bond market to get out of commodities, they may want to shift their attention between the VIX and the MOVE indices as regimes move.
These findings challenge a long-standing assumption: that the bond market always leads. At least when it comes to measuring future uncertainty, equities seem to set the tone, except, notably, in the most volatile moments, when bonds regain their influence. It appears that, in general, the bond market is looking more to the equity market for future assessments of risk rather than the other way around. These results merit further study, not just into which market is leading the other, but how this spillover of uncertainty travels between them.
