Bond market: The bond market does not see the end of the worst turbulence since the credit crash
The world’s largest bond market is in the grip of its longest period of sustained volatility since the start of the financial crisis in 2007, marking a sharp break with the stability seen during the long period of historically low interest rates. And the uncertainty that fuels it doesn’t seem likely 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 has difficult to assess how well a still resilient economy will hold up.
The result is that fund managers see no respite from the turmoil.
“Bond market volatility will remain high 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 rate hikes next year only to resume if the economy is stronger than expected.
Sustained volatility pushed some major buyers away, draining liquidity from a market struggling with the worst annual loss since at least the early 1970s. Analysts at Bank of America Corp. warned that Treasury market liquidity – or the ease with which bonds are traded – has deteriorated to its worst since the March 2020 Covid crash, leaving it “fragile and vulnerable to shocks”. After falling from June to early August, Treasury yields rebounded as a key measure of inflation jumped in September to its highest level since 1982 and employment remained strong. Those numbers and comments from Fed officials have led the market to expect the Fed to push its rate to a high near 5% early next year, from a range of 3 to 3.25. % currently.
Major data releases for the coming week are unlikely to change this outlook. The Commerce Department is expected to report that an inflation indicator, the Personal Consumption Expenditure Index, accelerated to an annual rate of 6.3% in September while the economy grew 2.1% in the third quarter, rebounding from the decline of the previous three months. Meanwhile, central bank officials will be in their self-imposed period of calm ahead of their November meeting.
The widespread expectation that the Fed will adopt its fourth consecutive 0.75 percentage point on November 2 has indeed raised questions about the direction of monetary policy next year. There is still considerable debate about where the Fed’s key rate will eventually hit and whether it will drag the economy into a recession, especially given the growing risks of a global slowdown as central banks around the world whole are tightening together.
The uncertainty was underscored on Friday, when two-year Treasury yields rose, falling as much as 16 basis points after the Wall Street Journal reported the Fed would likely discuss plans to potentially slow the pace of its rate hikes after next month.
“If they stop after inflation drops and the economy slows, market volatility will decrease,” said Steve Bartolini, fixed income portfolio manager at T. Rowe Price. “The day the Fed takes a break, volatility should drop, but we’re unlikely to return to the low-volume regime of the 2010s.”
While the high volatility may provide buying opportunities, any effort to bottom out has been thwarted as yields have risen. Additionally, investors are also aware that recessions and financial crises that have followed excessive monetary tightening in the past have been associated with notable spikes in volatility.
That potentially means 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 fundamental fixed income for the Americas. But for other investors “there will be opportunities to take advantage of market dislocations and build fixed income portfolios with attractive yields above 5%.”
Still, he expects the market to continue to be rocked by price swings. “Implied volatility is clearly the highest since 1987 outside of the global financial crisis,” Miller said. “We’re not going back to the experience of the previous decade,” he said, “anytime soon.”
What to watch
Economic calendar
Oct. 24: Chicago Fed Activity Index; S&P Global Manufacturing and Services PMIs
Oct. 25: FHFA house price index; Conference Board Consumer Confidence; Richmond Fed Manufacturing Index
Oct. 26: MBA mortgage applications; trade balance; wholesale and retail inventory; new home sales
Oct. 27: GDP; durable goods orders; applications for unemployment benefits; Kansas City Fed Manufacturing Index
Oct. 28: employment cost index; personal income and expenses; pending home sales; U. of Mich Inflation Sentiment and Expectations
Fed calendar: blackout period until November 1-2 meeting
Auction schedule:
October 24: 13 and 26 week invoices
October 25: 2-year tickets
October 26: 5-year bonds, 2-year floating rate bonds, 17-week bonds
October 27: 7-year tickets, 4-week and 8-week tickets
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