Jarred by daily double-digit moves in Treasury yields, bond investors are bracing for at least another year of rocky trading, abandoning hopes that in 2023 the market would return to normality.
That’s forcing them to ditch their old playbooks designed during calmer and more predictable times and look for flexible and nimble investments to ride the most-turbulent market since 2008.
Traders got another taste this week of the contrasting forces battering the market with bonds falling after a surprise cut to global oil production, only to bounce back hours later following weak economic data. That tone continued to prevail Tuesday after a softer reading on US job openings sent the two-year yield slumping sharply below 4%.
Trading in this environment requires more agility and a willingness to step in and opportunistically buy or sell when yields swing to extremes. It won’t be until the Federal Reserve ends its tightening cycle and the economic picture gets clearer that the market regains a more sustainable sense of calm, according to George Goncalves, head of macro strategy at MUFG.
It “was just wishful thinking” to hope for less rate volatility this year, Goncalves said. “It may not be until mid-2024 that rate volatility settles.”
With so much to digest in such a short period of time, the first quarter felt like a full year of drama for investors in the $24 trillion US Treasury market.
Recession fears in the initial weeks of 2023 moderated to hopes of a soft-landing, before morphing into the prospect of no-landing in February after stronger-than-forecast jobs and inflation readings fueled bets on higher rates. By early March, the two-year yield soared to as high as 5.08% — climbing over 100 basis points from its mid-January trough.
The rip higher in Treasury rates was turbocharged when Fed Chair Jerome Powell indicated a willingness to accelerate the pace of monetary tightening — only for the failure of Silicon Valley Bank days later to ignite a brutal flight to bonds that echoed the frenzy for haven assets seen during the global financial crisis. Two-year yields plunged over 60 basis points in a single session, finally bottoming out at 3.55%.
Bond veteran Vineer Bhansali, founder of LongTail Alpha LLC, said that in the past 35 years he’s never seen anything like that happen with rates in those shorter maturities. And such pronounced swings are certainly weighing on his investment decisions these days.
“I’m not willing to take much duration risk because I don’t really know if we fall into an abyss and rates rally, or everything stabilizes,” said Bhansali, who’s also the former head of analytics for portfolio management at Pacific Investment Management Co. “What I am primarily trading is the yield curve, wagering on steepening.”
Under so much uncertainty, it was hardly surprising to see the ICE BofA MOVE Index, a closely watched proxy of expected Treasury swings, climb to its highest since 2008 — more than doubling from the end of January.
Yet even that advance underplays the extent of price fluctuations. Put simply, the mid-March swing in two-year yields was the biggest since 1982, when then Fed Chair Paul Volcker slashed rates as a recession eased.
To Steve Bartolini, portfolio manager at T. Rowe Price, the two-year yield will continue to be more volatile than the rest of the curve as it reflects the market’s outlook for rate cuts and hikes.
That was evident on Monday when the two-year yield swung 17 basis points after a surprise oil production cut by OPEC+ was followed by a weaker US manufacturing survey. With the softer labor-market reading on Tuesday, the two-year swung 20 basis points. In the wake of the banking crisis, traders are trying to decipher how much tightening in financial conditions will potentially take the place of Fed rate hikes ahead.
Swap traders for their part are now back to pricing in a one-in-two chance of a quarter-point rate hike in May after leaning harder in that direction at the start of the week before the jobs-opening data. The Fed is expected to slash the funds rate to about 4.30% by year end. That’s well below the median forecast from US officials of 5.1%, according to the latest “dot plot” of quarterly economic projections.
Investors backing that view include Darren Davy, the 56-year-old alum of Soros Fund Management who’s affiliated now with Lee Cooperman’s Omega Family Office.
“For the next 12 to 18 months, we are going to go through a very interesting global fixed-income transition,” said Davy, who’s been working in markets for 36 years. “In this type of volatility environment, you have to be very, very careful. Overall, there’s more a story now about a continued normalizing of yield curves and the risk to duration – which should have a premium.”
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