Tuesday, January 18

Traders are dealing with a whole new world of bond volatility


Bond volatility is accelerating as Covid-19 and inflationary fears wreak havoc on the policy outlook.

Federal Reserve Chairman Jerome Powell sparked further turmoil Tuesday by suggesting stubbornly high inflation justified an increase in the pace of policy tightening, adding potential upward pressure to bond yields. At the same time, fears about omicron’s resistance to existing vaccines had pushed the 10-year benchmark yields to a two-month low this week.

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Bond trading threatens to aggravate the nervousness that has spread through financial markets as the recovery from the pandemic threatens to derail. The greater the volatility of the debt market, the greater the possibility that it will leak out to spook stocks, which are still not far from all-time highs despite this week’s declines.

Hedge funds have suffered losses in recent months when bond yields spiked on inflationary bets. Then, when investors advanced betting on rate hikes, central banks rejected those expectations to drive down yields.

After insisting for months that inflation is likely transitory, Powell in testimony before the Senate Banking Committee said it was time to withdraw the mandate and possibly for the Fed to move more quickly toward raising interest rates by closing. your faster asset purchase program. The new variant of the coronavirus, which caused a growth scare last week, also has inflationary potential by worsening supply chain problems, he said.

Transition time

“What’s going to create a lot of volatility is the transition from one environment to another,” said Kathryn Kaminski, chief research strategist and portfolio manager at AlphaSimplex Group in Cambridge, Massachusetts, which oversees about $ 6.4 billion. Powell getting rid of how “transient” is “this pivot in a different environment from a macro perspective,” he said.

The June 2022 Eurodollar futures contract, which can be used to bet on Fed policy, has experienced historic volatility over a five-day period to the highest in more than a year. At the same time, its 50-day average has been on the rise since mid-September. Meanwhile, the implied volatility of the Treasury market over the next 30 days, as measured by the ICE BofA MOVE index, has risen to the highest level since the initial settlement of the pandemic in March 2020.

Volatility is also increasing in the Asia-Pacific markets. A measure of implied swings in Japanese bonds jumped to the highest level since March, while swings in Australian 10-year bond futures last week rose to their highest level since April.

US 10-year yields rose three basis points Wednesday to 1.48%, after falling five basis points on Tuesday. Two-year yields rose three basis points to 0.59%, approaching the peak of 0.65% reached last week, the highest since March 2020.

“A week ago, the Treasury market was bracing for a higher interest rate environment next year,” said Michael O’Rourke, chief market strategist at JonesTrading Institutional Services in Stamford, Connecticut. “This Treasury contraction in reaction to the omicron caught investors off guard, and now Powell’s comments caught them off guard once again. That sets the stage for additional volatility for both bonds and stocks. ”

US payroll data on Friday, inflation figures next week and the Fed meeting in mid-December will face this feverish macro environment, as well as end-of-year liquidity constraints. year that can also promote volatility.

“November data will show high payroll and inflation and reveal that the Fed is behind the curve, while omicron leaves the data horizon looking more confusing,” said John Brady, managing director of RJ O’Brien, a brokerage. futures in Chicago. “The Fed’s policy meetings and the release of data providing an update on the likely trajectory of inflation will support volatility.”

© 2021 Bloomberg


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