The year 2023 has been remarkable. It began with high volatility and depressed asset prices, only to see stocks surge while volatility fell back to levels not seen consistently since the 2010s.
And while U.S. equity markets may be ending the year at or near their 2023 highs, the year was a quagmire for two markets: bonds and foreign exchange (FX). Nevertheless, the persistently elevated volatility in the former and the complete lack thereof in the latter may offer the greatest opportunities in the new year.
Sell bond volatility when it rises
The Federal Reserve has finished raising rates, and rate cuts will materialize in 2024 before the presidential election. The U.S. economy is slowing; whether that means a recession or simply a period of slower growth is still open for debate. Either way, U.S. Treasury bonds have bottomed, and receding growth and inflation expectations should further undercut yields in 2024.
Unlike 2023, when bond market volatility was elevated along all parts of the curve effectively all year long, the shifting fundamental environment suggests bond market volatility should steadily recede over the coming months. If yields spike higher and bond vol rises alongside, fade it.
The directional assumption for U.S. Treasury yields goes beyond fundamental prognostications. Take the U.S. Treasury 10-year yield chart: in Q4 ’23, it fell below the rising trendline from the May, July and September swing lows, as well as the neckline of a head and shoulders topping pattern around 4.472%. Technically, charts have turned the corner, suggesting tops have formed in yields and bottoms have formed in prices.
Tickers to watch: /ZN, /ZB
Preferred strategy: Selling OTM put spreads
Long deltas in the Japanese yen
If we’re looking at a world where the Federal Reserve is finished raising rates and U.S. Treasury yields are coming down, one currency stands to benefit more than others: the Japanese yen. Widening interest rate differentials and a growing chasm between Bank of Japan (BOJ) monetary policy and other central banks’ rate hike efforts proved to be a death knell for the yen in 2022 and 2023.
But as tightening cycles around the world are finishing up, the BOJ appears ready to end its extraordinarily accommodative policies. Divergence between the Fed and the BOJ will yield toward converge, which can only stand to help the beleaguered yen—particularly if the global economy lurches into a recession.
As global bond yields receded at the end of 2023, the Japanese yen (/6J) was able to break its multi-month downtrend from the March and July 2023 swing highs. The technical tailwind, coupled with the shift in fundamentals, makes for an appealing trade setup for at least the first half of 2024.
Tickers to watch: /6J
Preferred strategy: Long futures or short OTM puts + long OTM calls.
Christopher Vecchio, CFA, head of futures and forex at tastylive, forecasts economic trends in a number of countries. @cvecchiofx