Bond Trading May Be Sending a Recession Warning

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In the typically tame market for government bonds, investors have been left reeling from some of the most chaotic trading conditions they have ever seen, entrenching concerns about the broader economy since the collapse of Silicon Valley Bank.

It’s the kind of trading that makes the often more turbulent stock market seem calm: While the S&P 500 has edged higher in the two weeks since the federal authorities took control of SVB, parts of the government bond market have been subjected to moves not seen since the 1980s, when the economy fell into recession after the Federal Reserve’s last major fight against inflation.

The wild trading strikes at the heart of the financial system. U.S. government bonds, called Treasuries, are the bedrock of global markets. A rise or fall in Treasury yields, which move in the opposite direction to their price, can ripple through to everything from mortgages to company borrowing — affecting trillions of dollars’ worth of debt.

Usually, yields on these bonds rise and fall in tiny increments measured in hundredths of a percentage point, or “basis points.” But in the past two weeks, the yield on two-year Treasury notes has consistently moved within a range of 0.3 to 0.7 percentage points each day.

That may still seem incremental, but it’s as much as 15 times the average over the past decade.

The largest day-to-day move in yields this month, when the two-year yield on March 13 slid to 3.98 percent from 4.59 percent, was the biggest lurch lower since 1982 — worse than anything traders witnessed in the 1987 “Black Monday” stock market crash, the bursting of the tech bubble at the turn of the century or the 2008 financial crisis.

“These are monster moves for single days,” said Sonal Desai, chief investment officer at Franklin Templeton Fixed Income. “It’s completely bonkers.”

When traders talk about gyrations in any market, they describe it as volatility. Loosely, that refers to the size and speed of movements in the market. In the stock market, one measure of volatility — the Vix Index, also known as Wall Street’s “fear gauge” — rose over the past couple of weeks, but not to levels that conveyed systemic panic. Its still well below where it was in past crises, like the start of the coronavirus pandemic or 2008. It’s not even at its highest level in the past 12 months.

But in the Treasury market, a similar volatility measure has hit levels last seen at the end of 2008, just a couple of months after Lehman Brothers’ fall triggered economic pandemonium.

“What we have gone through, I have never seen it before,” said George Goncalves, head of macro strategy at MUFG Securities. “It was off the charts.”

Even since that March 13 plunge, the yield on two-year notes has gyrated sharply higher and lower. In a period of anxiety over the state of the economy, these swings stand out. Illustrated on a chart they resemble a sound wave that quieted after the last financial crisis but is growing louder again.

On Friday, the two-year yield dropped again, falling as much as 0.3 percentage points before snapping back.

“The volatility is just extreme,” said Greg Peters, co-chief investment officer at PGIM Fixed Income. “How can one have confidence around investing, how does one put a stake in the ground and say they firmly believe something, when it is just so, so volatile?”

That also suggests that these swings won’t end soon, in particular as investors consider more economic data and changing outlooks for everything from the Fed’s plan for interest rates to whether the financial system has stabilized or not.

“There is just so much uncertainty,” Mr. Peters said. “The volatility creates volatility.”

It’s not just the turbulence that has rattled investors but the sharp change in what it communicates about the health of the economy.

On March 7, just three days before Silicon Valley Bank collapsed, the Fed chair, Jerome H. Powell, spoke to Congress and opened the door to raising interest rates higher and faster than previously thought, in response to hotter-than-expected inflation data. The two-year yield rose above 5 percent for the first time since 2007 — a sign that investors were listening to Mr. Powell and pricing in the prospect of higher interest rates.

But the collapse of the bank meant those bets quickly soured, crushing some investors. On Thursday, the two-year yield stood at just 3.83 percent, and investors have since placed bets that the Fed will begin cutting interest rates this year in a bid to support the economy — a forecast that suggests “the mother of all recessions” is on the horizon, Ms. Desai said.

She thinks this is an overreaction, at least for now, she said. She notes that stock markets have remained resilient and that corporate bonds, which reflect the likelihood that companies may fall into trouble, have yet to set off alarm bells.

Instead, Ms. Desai said, she thinks that investors have grown to expect the Fed to come to their rescue as soon as financial markets sputter.

“It feels much more like the market desperately wants to be thrown the lifeline in the form of interest rate cuts,” she said.

Others read the moves differently, arguing that investors ignore the more dour signal from the Treasury market at their peril, and that a recession is in fact on the way.

“We have had this fantasy that we can raise rates and that it wouldn’t leave its imprint on markets and the economy,” Mr. Goncalves said. “Why are we in shock? I think the damage is done.”

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