Political uncertainty feeds US rates volatility

Despite the end of large scale hostilities in Iraq, continuing political uncertainty in the wake of the war is likely to cause increased intra-day US interest rates volatility in the short term, according to research by Deutsche Bank.

Volatility has steadily declined since the war drew to a close. However, continuing civil unrest in Iraq and the potential for future political or military conflicts involving the US is likely to prevent implied volatility from dramatically declining further.

In its latest fixed income research note, Deutsche highlights that the largest recent decline in volatility occurred for options with tenors of two years and five years.

For example, a one-year option on a two-year swap declined by around 20 basis points between the beginning of the war in mid-March and the end of last week. Meanwhile, the change for the option on the 10-year swap during the same period was around 14bps.