2022 Rivals 2008 For Suddenly Wild Bond Market

“Keep those seatbelts fastened,” TD’s Priya Misra said, in a note documenting this year’s fireworks in US Treasurys.

Over the past several weeks, market participants have witnessed daily swings in US rates the likes of which many of Wall Street’s younger strategists, analysts and traders have never seen in their careers.

An already dramatic orchestra crescendoed this month, when the combination of a red-hot CPI report and a Wall Street Journal article tipping the Fed’s intention to deliver the largest rate hike since 1994, triggered the biggest two-session surge in front-end US yields in four decades (figure below).

Since then, yields have come down due to, among other things, recession fears, which prompted traders to reconsider some of the more aggressive assumptions about the Fed’s rate path.

In short: Both traders and policymakers are flying almost totally blind in an environment of lackluster liquidity and impaired dealer intermediation. Hence the whipsaw.

If you’re curious as to just how anomalous 2022 is when it comes to US rates, TD’s Misra noted that based on the share of days when daily moves in 10s exceeded one standard deviation, this year rivals 2008 (figure below).

Misra ran the same numbers for 2s, for which the number of two-sigma and three-sigma daily moves is even larger.

“While high inflation should force the Fed to continue hiking, the market has become concerned that the tightening in financial conditions and negative real wages will slow growth,” Misra wrote, explaining the macro catalysts behind outsized daily swings, on the way to addressing pervasive market structure issues. “Regulations have resulted in impaired dealer intermediation, and that is most apparent when volatility picks up and Principle Trading Firms tend to reduce their market-making activities,” she said, noting that “even as 10-year rates made highs not seen since 2011 and mutual funds have seen outflows, dealer inventories have not risen… in sharp contrast to the rise in rates during the taper tantrum or in late 2018.”

The juxtaposition between rates turbulence and implied equity vol is a hot topic. “Rates/equity volatility remains the key risk metric as FOMC efforts to map a medium-term path for funds back in May have gone up in smoke,” UBS’s Stuart Kaiser said. The MOVE is still very elevated (figure below).

There are myriad explanations for the “too low” VIX, but the overarching takeaway is that rates are the sponsor of 2022’s ongoing market disturbance. That’s a nightmare for multi-asset investors: Your risk-free asset is the proximate cause of the problem and far from being a buffer, bonds are a source of portfolio volatility.

This is the backdrop against which the Fed is attempting to run down its $9 trillion balance sheet. During testimony on Capitol Hill last week, Jerome Powell told lawmakers the Fed currently doesn’t see “anything concerning” as it relates to market illiquidity.

So far, QT is working, Jim Bullard said Friday in Zurich. He conceded it’s too early to draw any conclusions, though. After all, it just started this month.