Bond Market Sees No End to Worst Turbulence Since Credit Crash

(Bloomberg) – For bond traders, the upward trend in Treasury yields hasn’t been that hard to predict. It is the short-term fluctuations that are irritating.

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The world’s largest bond market has been hit by its longest sustained volatility since the start of the financial crisis in 2007, marking a sharp break with the stability seen during the long era of historically low interest rates. And the uncertainty that is driving it doesn’t look set to vanish anytime soon: Inflation is still at its highest in four decades, the Federal Reserve is aggressively raising interest rates, and Wall Street is struggling to gauge how well an economy is. still resilient will hold up.

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

“Bond market volatility will remain high for the next six to 12 months,” said Anwiti Bahuguna, Columbia Threadneedle’s portfolio manager and head of multi-asset strategy. He said the Fed could suspend its rate hikes next year only to pick up if the economy is stronger than expected.

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Sustained volatility has pushed some major buyers to the sidelines, draining liquidity from a market struggling with its worst annual loss since at least the early 1970s. On Thursday, analysts at Bank of America Corp. warned that Treasury market liquidity – or the ease with which bonds are traded – has worsened for its worst since the March 2020 Covid crash, leaving it “fragile and vulnerable to shocks” .

After retreating from June to early August, Treasury yields began to rise again as a key measure of inflation jumped in September to its highest since 1982 and employment remained strong. These figures and comments from Fed officials have led the market to expect the Fed to push its rate to a peak close to 5% early next year, from a range of 3-3.25% today.

Next week’s major data releases are not expected to change this outlook. The Commerce Department is expected to report that an inflation indicator, the Personal Consumption Spending Index, accelerated to an annual pace of 6.3% in September while the economy grew 2.1% during the third quarter. , rebounding from the decline of the previous three months. Meanwhile, central bank officials will be in their self-imposed lull before the 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 indeed raised questions about where monetary policy will head next year. There is still considerable debate over how high the Fed’s key rate will eventually rise and whether it will drive the economy into a recession, especially given the growing risks of a global slowdown as central banks around the world tighten in concert.

Uncertainty was highlighted on Friday as two-year Treasury yields rose, then plummeted to 16 basis points after the Wall Street Journal reported that the Fed is likely to discuss plans to potentially slow its pace. rate hikes after next month.

“If they stop after inflation is down and the economy is slowing, market volatility will decrease,” said Steve Bartolini, T. Rowe Price’s fixed income portfolio manager. “The day the Fed takes a break should see volatility drop, but we are unlikely to return to the low-volume regime of the 2010s.”

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While the high volatility may provide buying opportunities, any attempt to call a low has been thwarted as yields have risen. Furthermore, investors are also aware that the past recessions and financial crises following excessive monetary tightening have been associated with significant spikes in volatility.

This could potentially mean more pain for leveraged financial investments that have taken off in a world of low inflation, rates and volatility, said Bob Miller of BlackRock Inc., head of American fundamental fixed income. But for other investors, “there will be opportunities to take advantage of market dislocations and build fixed income portfolios with attractive returns above 5%”.

However, he expects the market to continue to be affected by price swings. “Implied volatility is clearly the highest since 1987 outside the global financial crisis,” Miller said. “We will not go back to the experience of the previous decade,” he said, “shortly”.

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