Traders are learning to live with outsized moves and pervasive cross-asset volatility. Or, if they aren’t, they’ll need to. We’re not in Kansas anymore.
It’s tempting to leap at every opportunity to document the latest manifestation of the ongoing tantrum across developed market rates — to marvel at “today’s” multi-standard deviation event.
Going down that road sets a somewhat dubious precedent, though. By all indications, volatility in rates and, increasingly, FX, will be with us for the foreseeable future, and given how somnolent (or outright moribund) some of the relevant markets were during the long period of QE and forward guidance, the exit from that regime will invariably produce near daily disturbances.
On Wednesday, for example, the Bank of Japan’s tense standoff with traders keen to challenge the sustainability of the bank’s YCC regime amid acute pressure on the currency and ever wider rate differentials with the US, produced a wild drop in JGB futures (figure below).
The largest drop in nearly a decade was juxtaposed with cash yields, which the BoJ managed to contain. The bank will conduct unlimited bond-buying ops of cheapest-to-delivers on Thursday and Friday at the upper-end of the YCC band. Swaps and futures were largely unresponsive to bond purchases earlier this week, even as the buying “drove down yields sharply from their highs,” Nomura’s Takenobu Nakashima remarked.
This is becoming extremely problematic for the BoJ, which meets Friday. Upward pressure on yields amid an ongoing selloff in global rates is forcing the bank to defend the 0.25% line in the sand on 10s, but doing so amounts to easing, which only exacerbates the policy divergence with the Fed, especially now that US policymakers are poised to ramp up efforts to fight inflation with larger rate hike increments. That widening policy divergence piles pressure on the beleaguered yen, which weakened to the lowest since 1998 on Wednesday.
I’ve been reluctant to countenance the idea that the BoJ will be forced to abandon YCC, but at the very least, they may have to widen the band. Otherwise, they’ll have to keep printing money until US yields retreat, which would act as a pressure release valve of sorts.
The market is rife with speculation that Kuroda will throw in the towel, à la the RBA, which abandoned a short-lived experiment with YCC late last year, when yields on the target three-year note rose to eight times the cap.
Speaking of three-year yields in Australia, they notched the largest two-day jump in nearly 30 years this week (figure below).
The shaded rectangle covers the YCC regime. The two-day surge came on the heels of a mind-bending jump in front-end US yields which posted the largest two-day increase in four decades on Friday and Monday.
The catalyst on Wednesday was a larger-than-expected increase in the national minimum wage, which will rise by 5.2%, according to the Fair Work Commission’s annual review.
That reinforced concerns over a wage-price spiral, and came a day after Philip Lowe, whose dramatic about-face on rate hikes culminated in a surprise 50bps increase last week, told ABC TV that inflation in Australia may rise to 7% by year-end.
During the same Tuesday television interview, Lowe said Australians should prepare for higher interest rates. “The emergency’s over,” he told the nation.
The public health emergency may be over. But if the increasing frequency of anomalous price action like that shown above is any indication, the emergency in markets is just beginning.
Still looking down the barrel at the SEP and a Powell presser, quad OpEx, a flurry of other central bank mtgs, bank stress tests and a possible Russian default. Get the Darkenfloxx™ ready.