Cracks appear in the world’s largest bond market as the Fed retreats


(Bloomberg) – Warning signs begin flashing on regulators in the US $ 22 trillion Treasury market, which is being hit by volatility just as the Federal Reserve begins to retreat from its $ 80 billion a month buying spree.

Most read by Bloomberg

Spurred by a report on rising inflation that led traders to shift the timetable for the Fed’s first rate hike, the two-year Treasury yield rose nearly 10 basis points on Wednesday, its biggest move. large since March 2020. It ended a period of extraordinary volatility that led to the rockiest 30-year bond auction in the last decade and brought a market liquidity indicator to the most troubled level since the collapse immediately after Covid- 19 hit the United States

The cracks are appearing just as market supervisors virtually gather on Wednesday for an annual event that has been held since 2015, a year after a 12-minute “flash hike” when yields plummeted and rebounded with no apparent trigger. This shouldn’t happen in the largest debt market in the world. The agenda is to consider “proposals to improve the functioning and resilience of the market in general”.

The urgency could grow by then. The Fed, which has consistently bought Treasuries since the start of the pandemic, has almost froze trading, is rolling out plans to begin scaling back its purchases by $ 10 billion a month. And as regulators get together, the Treasury Department will hold its monthly 20-year bond auction, providing a test to see if this week’s 30-year sale was an anomaly or a sign that the market’s ability to running smoothly could be jeopardized as the bank withdraws its support.

“The current structure allows the market to perform well when volumes are around medium levels,” said Peter Tchir, head of macro strategy at Academy Securities. “But it leads to these periods of large and aggressive movements that seem inexplicable by the data. It also makes it difficult for asset managers to manage their risk. “

This was shown this week, when Bloomberg’s US government bond liquidity index – which measures how far yields diverge from a fair value model – showed conditions were the worst since March 2020.

The anomalies in the price of Treasuries have broad effects because their yields are used to value more than $ 50 trillion of assets around the world. Within the Treasury market, trading in notes and bonds issued in past years – known as off-the-run securities – is difficult under normal circumstances and even more cumbersome when liquidity dwindles, Tchir said.

Treasury Undersecretary for Internal Finance, Nellie Liang, as well as her Deputy Assistant Secretary, Brian Smith, will attend the conference. US central bank officials include New York Fed Chairman John Williams and Lorie Logan, System Open Market Account manager at the reserve bank, and senior officials from the Commodity Futures Trading Commission and Securities will also participate in the webcast. and Exchange Commission event.

Recent swings in the Treasury market reflect broad uncertainty over the direction of the economy and monetary policy amid rising prices, labor shortages and yields well below the inflation rate.

The Treasury’s sale of $ 25 billion in new 30-year bonds on Wednesday yielded more than five basis points higher than the pre-auction trading yield just before the offer expired, a sign of weak demand. The so-called tail has been the worst for a bond auction since August 2011.

“A five basis point auction queue is a clear sign of illiquidity,” said Michael Cloherty, head of US rate strategy at UBS Group AG. “The market has been extraordinarily erratic in the past two weeks and is struggling to handle large risk transfers.”

U.S. regulators have taken action since the chaos of March 2020 forced the Fed to step in and buy billions of dollars of debt every day to keep the market going.

The Treasury Market Surveillance Inter-Agency Working Group released an update this month showing that they are getting closer to proposing new reforms. The group’s progress report showed continued interest in expanding central clearing, improving transparency on dealership business, and improving the supervision of trading venues, among other measures.

Related Story: Federal Regulators Closer to Treasury Market Reforms

The recent bout of volatility surprised some investors, who expected the market to stabilize after Fed Chairman Jerome Powell indicated this month that he was in no rush to raise rates. Instead, the ICE BofA MOVE Index, an indicator that measures implied future swings in the yields of Treasuries embedded in option prices, is now close to its highest since around April 2020.

“We are in a transition period now, not only with monetary policy, but also given the many uncertainties out there, including where fiscal policy is headed and with geopolitics,” said Jerome Schneider, chief of management and financing of the short-term portfolio. at Pacific Investment Management Co., which manages approximately $ 2.2 trillion in assets.

“People have become very lethargic in thinking about how liquidity is distributed across the global financial system because monetary policy has been incredibly easy,” he said. “This is changing slightly now.”

What to watch

  • The economic calendar

    • November 15: Manufactory of the Empire

    • November 16: Retail Sales; import / export prices; industrial production; business inventories; NAHB Real estate market index; International Treasury Capital Flows

    • November 17: MBA Mortgage Applications; building permits; the accommodation begins

    • November 18: jobless claims; Economic Outlook of the Philadelphia Fed: Long Consumer Comfort; main index; Kansas City Fed Manufacturing Index

  • The Fed calendar:

    • November 16: Thomas Barkin of the Richmond Fed; Esther George of the Kansas City Fed; Raphael Bostic of the Atlanta Fed; Mary Daly of the San Francisco Fed

    • November 17: Fed Governor Michelle Bowman; Loretta Mester of the Cleveland Fed; Governor Christopher Waller; Mary Daly of the San Francisco Fed; Charles Evans of the Chicago Fed; Bostic

    • November 18: Bostic; Evans; Daly

    • November 19: Waller; Fed Vice President Richard Clarida

  • The auction calendar:

    • November 15: 13, 26 week bills

    • November 5: 20-year bonds

    • November 18: 4, 8 week bills; Reopening of the TIPS at 10 years

Most read by Bloomberg Businessweek

© 2021 Bloomberg LP


Please enter your comment!
Please enter your name here