Rates, Volatility and the Virus: Visualisations of key market drivers in 2020

In 2020 we had some unprecedented movements in global markets coming from the Covid-19 pandemic. Initially the hit to asset prices was tremendous and volatility got to highs not seen for a long time. For a moment, the paradigm of putting on a carry trades in all asset classes, seemed completely vanished. But this short glimpse at how market forces could reach new equilibrium price levels, was just not bearable for institutions in developed capital markets. After years of ever increasing balance sheets of all mayor central banks, new and yet bigger stimulus was again the subscription. The path forward was clear: central banks stepped in and bought up virtually everything, and with their hands tied at the lower bound in rate setting, this time governments also joined the spending party. Investors quickly got the message: carry, buying the dip and leverage were again top of the agenda. For the rates market that meant more of the same from previous years: rock bottom interest rates and volatility. But let us now have a closer look at how this all played out after a short layout of our style of presentation.

Before writing this blog post I had in mind the tons of research banks produce when the year comes to a close. What I wanted to make different, was the static nature of all this. Sure thing, researcher can pick interesting points and visually present it to their readers. But that is always a subjective choice. So wouldn’t it be nice to just slice through every trading day of the year by yourself and pick interesting things on your own? Or have the whole year played as an animation in as little as one minute time to grasp the dynamics? So I put on some animations, interactive charts which are a bit more "explorable". So let’s get started.

Our first chart is the EUR yield curve in 2020. The below chart has data points for all trading days in 2020 and can be slid through with the slider at the bottom of the figure. It can also be played as an animation. While the yield curves way to new lows by trading below zero in almost it’s entirety, is quite remarkable. Also the narrowing of the basis between 3M and 6M curve is worth mentioning. But see all this below:

For the narrowing it is quite interesting to look at how the curves underlying fixings actually evolved throughout the year:

Next thing we want to look at is rates volatility in the swaption market. Here we also have all data points, a slider, and the ability to play the whole thing as an animation. With regards to what happens, the overall bid to vol from Covid-19 is clearly the most remarkable. Breaking it down, it mostly hits short expiries and long tails, coming from the fear of massive flattening in the yield curve. On the contrary, volatility on short tails (top left) was staying relatively low, as rate cutting room for the ECB was perceived limited. After the storm passed, stimulus measures did their job, and more time went by towards years end, new lows were reached in rates volatility.

Another interesting thing to look at is what was implied in volatility during the year and what actually realized. Here you can look at different expiry times and tail combinations, just like on the swaption surface above. Only difference this time is that we compare an ex-post, what has realized, with an ex-ante measure (implied). Below we see this comparison for 1m10y:

Now we can compute the ratio of implied and realized volatility. A ratio below 1 indicates a buy signal. Below this is done for various expiry / tail combinations. As before, the data set is explorable by a slider and can be played as an animation as well. I think this data set gives a good feeling for the dynamics of how the underlying actually moved and what was implied throughout the year.

A final thing we want to look at is skew. It is interesting because it gives a sense of what the volatility market is charging for payer and receiver swaptions. That can in turn give us a hint at what the market is expecting from interest rates in the future (e. g. expensive payer swaptions vs. cheaper receiver swaptions are showing that market participants are protecting against rising interest rates). To see what has changed during the course of the year, we take beginning of year values and compare it to the most recent data. That should give us an indication of what has changed through Covid-19 and other events in 2020 in terms of expected interest rate movement in the future (or at least where protection buying is more expensive). Below we have various plots where we compare skew at the beginning and at the end of the year. This time we only have hover effects and no sliders and animation (maybe a project for the end of 2021 ;) ). What clearly comes out is that protection against up and down movements have both become more expensive (steeper skew). And for longer tails, the payer side has become even more expensive. So probably the market is looking at steeper yield curves.

As a final remark I wanted to highlight that this blog post was meant to show capabilities of technology for visualisation purposes first. So clearly, the dive into the research aspects could have been deeper. But I would be more than happy if you get in touch and want to discuss this area more thoroughly, as well as, of course, the technological matters of the outlined material. For me personally, I will definitely dig deeper in this interactive figures and also customized dashboards.