Rate Volatility Looks Mismatched to the Fed and Macro Risks Ahead
U.S. interest rate volatility is sitting near multi‑year lows even as policy and macro risks accumulate into year‑end and 2026, leaving outright short‑vol positions looking increasingly one‑sided. The ICE BofA MOVE Index, the “VIX of bonds,” closed around 75.4 on Tuesday—down from levels above 170 during the April 2025 hedge‑fund basis‑trade stress and roughly 40% below its 2023 banking‑crisis spike.
Short‑dated swaption implieds have followed suit, with three‑month volatility on 10‑year swap rates easing back to roughly 21–22 basis points after a brief flare‑up in mid‑November. Equity volatility tells a similar story: the VIX closed at 16.9 on Tuesday, versus intraday highs above 26 just weeks ago and an all‑time peak above 80 during the 2008–09 crisis.
This calm rests on a narrow set of assumptions: growth stays resilient, inflation continues to edge lower, and the Fed delivers about 100 basis points of additional cuts in 2026 on a smooth, predictable path. Deviation in either direction would force a rapid repricing of that path.
On the left tail, a weaker labor market—signaled by rising WARN notices and softer service‑sector hiring—could push the Fed into faster, deeper easing than currently priced, just as vol risk premia have been compressed. On the right tail, persistent inflation or deficit‑driven growth could derail hopes for a glide back to a roughly 3% neutral rate, forcing a higher‑for‑longer stance that lifts volatility, especially across the 2‑ to 5‑year sector.
A more openly divided FOMC raises the odds of sharper market swings around each meeting and data release, as doves argue for “required” easing while hawks remain wary of sticky inflation. Speculation that Kevin Hassett is the leading candidate for Fed chair has added another layer of uncertainty, with SOFR spreads starting to price a more aggressive front‑end easing path even though he would not take over until mid‑year and would replace an existing dove, Governor Stephen Miran.
Near term, the December FOMC decision, its updated Summary of Economic Projections, and the next round of tier‑one data are key catalysts. A break in the combined soft‑landing plus steady‑cut narrative—whether from weaker growth or stickier inflation—would likely force a reset of the entire rates path and push volatility higher from today’s compressed levels.
Vol may not revisit the extremes of the pandemic or the 2023 banking turmoil, but with macro risks and policy uncertainty elevated, 2026 looks more likely to bring an upswing in rate vol than another grind lower from here.
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