JPMorgan's Josh Younger on Rate Derivatives and Volatility Ahead of the Election

Episode Summary

Executive Summary: The episode examines how U.S. election uncertainty is being priced into volatility across asset classes, especially rates, and whether markets are appropriately hedged or still complacent. JPMorgan’s Josh Younger explains that options suggest elevated event risk, but much of the premium reflects potential post-election repricing, not just Election Day. The discussion also covers forward guidance, 2016 market memory, systematic volatility selling, and how a Biden presidency could alter the rates regime less through the election itself than through fiscal and Fed backstop dynamics.

Main Topics: Election risk and volatility pricing (Priority: 5/5): The hosts and guest discuss how markets are pricing the U.S. election as a tail-risk event, with implied volatility elevated around Election Day and potentially beyond it. How options reveal event risk (Priority: 5/5): Younger explains that comparing options expiring before and after the election helps isolate the premium investors are paying for election-related uncertainty. Rates market vs. equities in election sensitivity (Priority: 4/5): The conversation argues that interest rates may be more sensitive than stocks because fiscal and monetary policy outcomes could materially affect the Treasury curve and term premium. Why volatility sellers persist (Priority: 4/5): They explore why systematic options-selling remains profitable despite crowding, including dealer flows, institutional rebalancing, and jump-risk assumptions. 2016 as market memory (Priority: 4/5): The 2016 Trump surprise remains a key reference point, especially for rates volatility, shaping hedging behavior even though such elections are historically unusual. Forward guidance and Fed suppression of volatility (Priority: 4/5): The Fed’s strong guidance is portrayed as a major suppressor of volatility, especially in the 2- to 5-year part of the curve, by reducing uncertainty about policy. Volfefe and political communication risk (Priority: 3/5): Younger revisits the Volfefe index, which quantified market-moving Trump tweets, and notes a Biden presidency would likely reduce that source of market uncertainty.

Key Arguments: Election risk was priced as unusually large in late summer/early fall, with options implying several times normal daily movement across many asset classes. A portion of the election premium reflects uncertainty that extends beyond Election Day, including the possibility of a delayed count or contested result. Interest rates show especially strong election sensitivity because outcomes affect both fiscal policy and the Fed’s policy path, as well as Treasury market functioning. The 2016 election created strong muscle memory in rates markets, where the move was more chaotic than in equities, encouraging hedging ahead of 2020. It is functionally impossible for all investors to be fully hedged against a sufficiently large macro shock; residual exposures can force rapid repricing. Systematic volatility selling persists because options remain expensive on average and institutions can monetize that premium over time, even if the trade can look bad at the wrong moment. Forward guidance lowers volatility by reducing uncertainty about the likely path of rates, especially for options expiring a few years out. A Biden victory would likely reduce market uncertainty from presidential tweeting and policy-by-Twitter, but the bigger market issue is the fiscal path and Senate outcome. Markets and polling models incorporate past polling error, but investors still tend to focus more on the possibility of a Trump-style upset than on a large Biden mandate. A large Democratic sweep could itself be volatile because it may imply major policy shifts and raise questions about fiscal dominance and Fed backstopping of Treasury markets.

Data Points: Recording date: Tuesday, October 20 - The episode is recorded roughly two weeks before Election Day 2020. Election timing: Two weeks away from November 3 - Hosts frame the discussion as occurring just before the U.S. presidential election. Option-implied election-day move: 7 to 8 times the typical daily move - Younger says this was priced across multiple asset classes in late August/early September. Current option-implied election-day move: 3 to 4 times the typical daily move - He says the premium has come down but remains elevated relative to normal election cycles. Typical event risk premium: 2 to 3 times background volatility - He cites a rough historical norm going back about 25 years. VIX level referenced: 28.80 - The hosts use this as an example of the VIX quote and what it means. Trump campaign platform debt stock estimate: 125% of GDP - Younger cites Committee for a Responsible Budget estimates for long-run debt under Trump. Biden campaign platform debt stock estimate: 127% of GDP - Used to argue fiscal outlooks are similar across the two candidates. Prediction market/quant model Biden chance: About 65% - Younger references prediction markets as one view of the election odds. Quant election models Biden chance: About 70% to 75% - He cites models like 538 and others as clustering higher than prediction markets. Convergent model estimate: Around 90% - He says some election models converge near this level, despite different assumptions and inputs. Polling error characterization: One sigma - He describes 2016 as basically a one standard deviation polling error. Forward-guidance horizon: 2 to 5 years - Younger says forward guidance suppresses volatility most clearly out this far on the curve. Model input size: Around 1,200 features - The machine-learning rates model mentioned in the conversation uses many market and economic signals. Tweet database size: About 30,000 tweets - The Volfefe work analyzed Trump tweets to see which ones moved markets. Leverage in Fannie/Freddie strategy: 40 turns - Used to explain why selling mortgage-related options was lucrative historically. October 15, 2014 Treasury move: 30 basis points in 10 minutes - Cited as an example of jump risk in rates markets.

Pivotal Quotes: "It was something like seven to eight times the typical daily move priced for election day across really a broad range of asset classes." — Josh Younger: Explaining how options markets priced election-related risk in late summer/early fall 2020. "It is functionally impossible for everyone to be fully hedged in the event of a sufficiently large macro shock." — Josh Younger: On why volatility can still spike even when many investors think they are protected. "Forward guidance is very effective at suppressing volatility." — Josh Younger: Describing how Fed communication reduces uncertainty and depresses options pricing at medium maturities.

Implications: Investors should expect election-linked repricing even if the result matches polls, because positioning, policy shifts, and Treasury market functioning can all force volatility. The bigger risk may be the post-election regime change, not the day itself.