‘Volatility vortex’ descends on the $24 billion U.S. government bond market


The $24 billion U.S. Treasury market has been hit by its worst slump since the coronavirus crisis, underscoring how sharp swings in international bonds and currencies and jitters over rising U.S. rates have spooked investors. investors.

The Ice BofA Move Index, which tracks fixed income market volatility, hit its highest level since March 2020, a time when deep uncertainty about how the pandemic would affect the global economy sparked massive swings in US government bonds.

“Right now it’s all about market volatility,” said Gennadiy Goldberg, strategist at TD Securities. “You have investors who stay away because of volatility – and investors who stay away increase volatility. It’s a volatility vortex.

Fixed income investors’ nerves have been frayed by a series of events most commonly seen in market crises. Japan, the world’s third-largest economy, stepped in last week to defend the yen after the currency quickly fell to a 24-year low against the dollar. Days later, the UK government’s deep tax cut plans triggered a historic sell-off in the UK currency and sovereign debt markets.

These international events added to a powerful pullback in the US Treasury market which accelerated after the Federal Reserve announced its third straight 0.75 percentage point hike last week and announced a significantly tighter monetary policy at come.

The 10-year Treasury yield, a key benchmark for global borrowing costs, jumped to nearly 4% from 3.2% at the end of August, leaving it on the biggest monthly rise since 2003. It is on on track for its strongest consistent annual rise. The two-year rate, which is more sensitive to fluctuations in US monetary policy, jumped 3.55 percentage points this year, which would also mark a historic increase.

The big price moves have left investors wary of trading in a market that acts as the bedrock of the global financial system and is generally seen as a safe haven in times of crisis.

With investors on the sidelines, liquidity in the Treasury market — the ease with which traders buy and sell — has deteriorated to its worst level since March 2020, according to a Bloomberg index. Low liquidity tends to exacerbate price swings, thereby worsening volatility.

In a sign of how tough conditions are keeping some fund managers away, the United States attracted lackluster demand in sales this week for a total of $87 billion in new debt.

A two-year issue Monday priced at a high yield of 4.29%, while a five-year trade a day later priced at 4.23% – both marking the highest borrowing costs for the government since 2007.

The two-year debt was sold with the biggest difference – or “tail” – between what was expected just before the auction and its actual price since the Covid-induced market turmoil in 2020, said Tom Simons, money market economist at US investment bank Jefferies.

On Wednesday, the Treasury Department will auction $36 billion worth of seven-year notes. The seven-year note has struggled to attract demand in less volatile times, so the environment this week could pose a challenge.

“Until there’s more certainty, I think we’ll continue to have this ‘buyers’ strike,'” Simons said. “The markets are so crazy that it’s hard to price any kind of new [longer-dated bonds] come to market. »

Line chart of five-year auction yield (%) showing that the US government compensates investors more for buying Treasuries

A divergence between the Fed’s own interest rate outlook and market expectations added to the feeling of uncertainty.

According to their latest projections, most Fed officials now expect the fed funds rate to drop from its current target range of 3-3.25% to 4.4% by the end of the month. year. By the end of 2023, Fed officials expect interest rates to be at 4.6%.

Meanwhile, investors are betting the Fed will be forced to cut interest rates next year – with futures market expectations of a 4.5% peak in May 2023, with a drop to 4 .4% by the end of the year.

Given persistent and widespread price pressures, there is considerable uncertainty as to whether this degree of monetary tightening will be sufficient to bring inflation back to the Fed’s 2% target. Recession risks have also risen sharply, further clouding the outlook.

The strong rhetoric adopted by Fed officials on the central bank’s fight against inflation further stoked angst in the market. Many officials now agree that interest rates need to rise to a level that actively constrains the economy and stay there for an extended period.

“The only other time I saw us so united was at the start of the pandemic, when we knew we had to act boldly to support the economy during the pandemic and during the downturn,” said Neel Kashkari , chairman of the Minneapolis branch of the Fed, in an interview with the Wall Street Journal on Tuesday.

“We are all united in our work to bring inflation back to 2%, and we are committed to doing what we need to do to make that happen.”


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