Recent moves in small cap stocks such as Gamestop, and Vue, driven by the Wall Street bets retail crowd on Reddit challenged one of the most robust market structures in the world, namely equity markets.
Will this volatility create contagion in other asset classes such as OTC rates particularly with the current focus on the release of pent up consumer demand and the potential for increased inflation as exhibited by the steeper yield curve of late?
The short answer would be no. OTC rates markets are vast and liquid instruments that are used for hedging, not alpha and traded by market counterparts, not retail. They are also not small cap, less liquid stocks with well advertised short seller positions.
But is that too simple? OTC rates are linked to an underlying interest rate that has been creeping up due to inflation fears and is now feeding into equity market pricing. The retail crowd, with limited experience, reserves and risk appetite will then inevitably generate more equity volatility which in turn feeds back into rates markets.
What does this mean for OTC rates markets?
Unlike equities the OTC interest rate market structure is disparate and not as well defined. However, market practitioners still feel they have a duty of care to ensure they are doing everything they can to reduce and mitigate the market, operational and compliance risks associated with executing OTC interest rate swap instruments.
In the last 12 months there has been a significant increase in engagement from Asset Managers looking to improve their end-to-end OTC rates execution process. With the current backdrop of higher volatility, we predict this trend will continue throughout 2021 and beyond.