Bond Market Sees No End to Worst Turbulence Since Credit Crash

(Bloomberg) — For bond traders, the uptrend in Treasury yields hasn’t been that hard to predict. It’s the short-term changes that are annoying.

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The world’s largest bond market is being hit by its longest stretch of sustained volatility since the start of the financial crisis in 2007, marking a break from the stability seen during the long era of record-low interest rates. And the uncertainty that drives it doesn’t look like it’s going to fade any time soon: Inflation is still at its highest level in four decades, the Federal Reserve is raising interest rates aggressively, and Wall Street is struggling to measure how well a still resilient economy is doing. will hold

The result is that money managers see no respite from the turmoil.

“Bond market volatility is going to remain elevated for the next six to 12 months,” said Anwiti Bahuguna, portfolio manager and head of multi-asset strategy at Columbia Threadneedle. She said the Fed could pause its rate hikes next year only to resume them if the economy is stronger than expected.

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Sustained volatility has prompted some major buyers to sit on the sidelines, draining cash from a market facing its worst annual loss since at least the early 1970s. On Thursday, analysts at Bank of America Corp. They warned that the Treasury market’s liquidity, or the ease with which bonds trade, has deteriorated to the worst since the March 2020 Covid crash, leaving it “fragile and vulnerable to shock.”

After retreating from June to early August, Treasury yields have risen again as a key measure of inflation jumped to the highest level since 1982 in September and employment has remained strong. Those numbers and comments from Fed officials have led the market to expect the Fed to take its rate to a peak near 5% early next year, up from the current range of 3-3.25%.

Next week’s major data release is not expected to change that outlook. The Commerce Department is expected to report that a gauge of inflation, the personal consumption expenditures index, accelerated to a 6.3% annual pace in September, while the economy expanded 2.1% during the third quarter, recovering from the drop of the previous three months. Meanwhile, central bank officials will be in their self-imposed quiet period ahead of their November meeting.

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The widespread expectation that the Fed will enact its fourth consecutive 0.75 percentage point on November 2 has raised questions about where monetary policy is headed next year. There is still considerable debate about how high the key Fed rate will be and whether it will tip the economy into recession, especially given the growing risks of a global slowdown as central banks around the world tighten together.

The uncertainty was highlighted on Friday, when two-year Treasury yields rose, only to fall as much as 16 basis points after the Wall Street Journal reported that the Fed is likely to discuss plans to potentially slow the pace of its rate increases after next month.

“If they pause after inflation is falling and the economy is slowing, market volatility will decrease,” said Steve Bartolini, fixed income portfolio manager at T. Rowe Price. “The day the Fed pauses should see a decline in volatility, but we are unlikely to return to the low-volatility regime of the 2010s.”

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While high volatility may provide buying opportunities, any attempts to bottom were thwarted as yields rose. Furthermore, investors are also aware that recessions and financial crises following excessive monetary tightening in the past have been associated with notable spikes in volatility.

That potentially means more pain for leveraged financial investments that took off in a world of low inflation, rates and volatility, said Bob Miller, head of Americas fundamental fixed income at BlackRock Inc. But for other investors “there will be opportunities to take advantage of dislocations in markets and build fixed income portfolios with attractive yields above 5%”.

Still, he expects the market to continue to be affected by price swings. “Implied volatility is clearly the highest since 1987 outside of the global financial crisis,” Miller said. “We’re not going to go back to the experience of the previous decade,” he said, “any time soon.”

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