Bond Market Screams for Help But No One Answers
(Bloomberg Opinion) -- Thursday will go down in history as one of the wildest trading sessions ever in the $21 trillion market for U.S. Treasuries.
In early U.S. hours, the benchmark 10-year Treasury yield reached a new one-year high of 1.46%, just about the same as the dividend yield on the S&P 500 Index. I’ve flagged the level at which the two meet as a possible inflection point because it means that government bonds at least offer comparable income payments to stocks for the first time since before the Covid-19 pandemic.
Then something stranger happened: Traders aggressively sold shorter-term Treasuries, which had long remained relatively contained given the Federal Reserve’s commitment to keep interest rates near zero for years to come. Five-year yields surged about 15 basis points to 0.75%, a level flagged a week ago by Mizuho International Plc strategist Peter Chatwell as “a line in the sand that cannot be crossed without a meltdown.”
Finally, the wildest part of all: The Treasury Department’s $62 billion seven-year note sale was a complete disaster. The bid-to-cover ratio, an indicator of demand, was just 2.04, the lowest in the auction’s history. The offering had a “tail” of more than four basis points, the largest ever, meaning it yielded significantly more than Wall Street expected. Usually the difference is less than a basis point.
So by now, the world’s biggest bond market was clearly screaming for help — but few came to its rescue. That realization was alarming enough to spark something resembling a mini flash crash in what’s supposed to be the deepest and most liquid market anywhere.
Five-year yields jumped 10 basis points in an instant. Ten-year yields surged almost 12 basis points in a flash, to higher than 1.6%. The 30-year bond nearly reached 2.4%. The market retraced the moves within minutes, but it rightfully raises jitters about underlying demand for Treasuries. Is there anyone willing to step in and buy? Currency-hedged yields are the highest for Japanese investors in more than five years, but it’s possible they’re sitting out this selloff for now.
It would be hard to blame them. Treasuries, a “risk-off” asset, have delivered staggering losses to anyone holding them this year. The long portion of the Bloomberg Barclays U.S. Treasury Index is down more than 10% this year; its worse annual return on record is -12.9%. A Treasury bond with a 1.25% coupon that matures in May 2050 trades at less than 78 cents on the dollar, a price that in some corners of the bond market indicates distress. And now even shorter-term notes are feeling the pain.
The selling has been so fast and furious, in fact, that quant funds that follow market trends appear to be riding the momentum and betting on further losses. JPMorgan Chase & Co. strategists said their model is still a ways away from extreme levels that would indicate profit-taking will begin. To top it all off, investors in the $7 trillion mortgage-backed bond market are increasingly becoming forced sellers of Treasuries in what’s known as convexity hedging as they adjust for the reality that fewer Americans will refinance their old mortgages as interest rates increase, therefore extending the duration of their portfolios. Both of these dynamics probably helped contribute to the unruly conditions on Thursday.
Many strategists appear wary of calling for a reversal anytime soon, even if the impulse of many is to deem the move overdone. “The urgency of the global selling has not left a single reliable landmark that permits analysis of the steepening, much less any technical feel for what might come next,” Jim Vogel of FHN Financial wrote. “We’re strained in trying to find any appropriate historical analogy not based on a surprise move by the Fed.”
There’s only one thing that’s virtually guaranteed to stop Treasury yields from climbing: A stock-market rout. And no, five consecutive declines in the S&P 500 — -0.06%, -0.03%, -0.44%, -0.19% and -0.77% from Feb. 16 to Feb. 22 — don’t qualify.
Yes, the S&P 500 dropped 2.6% on Thursday, on pace for the biggest decline since October. But whether that continues in the face of relentless dip buying remains to be seen. The renewed frenzy in shares of GameStop Corp. and AMC Entertainment Inc. suggest individual day traders remain all too eager to plow their money into risky bets. Perhaps institutional investors, understanding the implications of rapidly rising interest rates, will sell into this equity market strength, leaving newbies on their own at all-time highs. That could set the stage for some serious pain.
At the moment, however, bond traders are staring down what could be the strongest economic growth since the 1950s and Fed officials who are all too eager to let inflation run hot and haven’t shown any indication that they’ll push back against the sharp increase in yields. Chair Jerome Powell called higher yields a “statement of confidence” in the economic outlook during congressional testimony this week, while St. Louis Fed President James Bullard said Thursday that rising yields were probably a “good sign” and not at the level where the move is worrisome. Atlanta Fed President Raphael Bostic made similar comments.
I wrote earlier this week that this isn’t a market tantrum, and I still think that’s the case, especially given that stock indexes remain near record highs. But the Treasury market is definitely starting to raise a ruckus. For now, the Fed and bond traders alike are leaving it alone to blow off steam.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Brian Chappatta is a Bloomberg Opinion columnist covering debt markets. He previously covered bonds for Bloomberg News. He is also a CFA charterholder.
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