JPMorgan says bond-market rally faces risk of ‘tantrum’ like 2013 and 2016

(MarketWatch) Complacent investors may see bond markets stage a tantrum that could bring back memories of volatility flare-ups from the last few years.

Nikolaos Panigirtzoglou of JPMorgan said, like 2013 and 2016, bond-market bulls who piled up long positions on Treasurys and other sovereign debt earlier this year during placid market conditions could all rush for the exit door at the same time, exacerbating the next selloff.

In a Friday research note, the global markets strategist for JPMorgan said one of the consequences of low interest rate policies by major central banks has been the increased frequency of surges in volatility as ill-prepared market participants, who made wagers assuming volatility would remain low, scrambled to cap their risk exposures from sharp bond-market moves.

The 10-year Treasury note yield was down 2.9 basis points to 2.015% on Monday, around 60 basis points lower from the beginning of the year, Tradeweb data show. The benchmark rate tumbled after the Federal Reserve pivoted to a more dovish stance as rising U.S.-China trade tensions stalled global economic momentum. Bond prices move in the opposite direction of yields.

Panigirtzoglou said there were more market participants who were particularly sensitive to shocks to “Value-at-Risk,” an indicator of risks around traders’ positions on any given day, such as hedge funds, risk-parity managers and commodity trading advisors. 

He also cited the deterioration in bond-market liquidity and outsized risk-taking in low volatility periods as potential contributors to the next VaR shock.

“Investors who target a stable Value-at-Risk, which is the size of their positions times volatility, tend to take larger positions when volatility is low. But the same investors are forced to cut their positions when volatility rises or hit by a shock, triggering self-reinforcing, volatility induced selling,” said Panigirtzoglou.

A sharp surge in bond-market volatility could therefore accelerate out of control. 

That is an increasingly likely scenario as the Treasurys market has come to life in recent weeks amid an uptick in uncertainty around the Fed’s future path for interest rates. 

The 1-month Merrill Lynch MOVE index, which tracks the one-month implied volatility for the 10-year Treasury note yield, was around 65 last Friday, around similar levels when bond yields slumped in December as part of a larger multi-month slide.

Analysts at JPMorgan also say that a 60 basis points decline in global bond yields this year would prove “unsustainable,” according to the bank’s index tracking sovereign debt in developed markets.

It isn’t just bond buyers who should maintain their vigilance against a reversal of a bond-market rally. Equity investors have also benefited from the sharp decline in bond yields, which have lifted stock-market valuations. Rising yields could undercut U.S. stocks at a time when they are trading near all-time highs even as global growth fears have led analysts to slash quarterly earnings forecasts.

The S&P 500 index and the Dow Jones Industrial Average are both off by less than 1% from their record close.

“Any abrupt bond selloff going forward is unlikely to be favorable to equities given the support that equity markets received from the strong rally in bond markets in recent months,” said Panigirtzoglou.


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