(Bloomberg) - Nearly a month after US government bond yields began a retreat from multi-year highs, fueled by creeping doubt the economy can stomach the Federal Reserve’s anti-inflationary medicine, the only certainty many investors are willing to commit to is that trading the market will remain perilous.
Treasury yields remain well off their mid-June peaks despite having ended the week higher, spurred Friday by resilient jobs data. But they’ve logged many of their biggest intraday swings of the year in the interim, and gauges of bond-market volatility have continued to climb. And next week brings the Consumer Price Index, the main US inflation gauge. Hotter-than-expected CPI data paved the way for last month’s yield peaks, which priced in the Fed’s subsequent shift to bigger rate increases.
For the bond market, the question is whether the June inflation gauges -- expected to show an overall increase of 8.8% from a year earlier, a new four-decade high -- alters expectations for what the Fed will do next. Friday’s jobs data helped solidify the consensus for another three-quarter-point rate increase on July 27, and lifted the expected peak in the policy rate back to around 3.60%, in March 2023. Swap contracts referencing Fed meetings dates continue to price in an end-2023 rate closer to 3%, though, predicting rate cuts will be needed by that point.
“It’s just getting more and more difficult for anyone to see the outcome for all this,” in regard to where Fed policy finally ends, said Peter Yi, director of short-duration fixed income and head of credit research at Northern Trust Asset Management. “There’s such a dispersion in terms of where the market sees things. It just seems like volatility has gone straight up.”
That’s only a slight overstatement. A broad gauge of Treasury market volatility, the ICE BofA MOVE index, is just shy of its March 2020 peak. Shorter-term measures based on options on interest-rate swaps have already exceeded those levels and are back to 2008 financial crisis levels.
Underlying the gauges are big intraday yield moves occurring with alarming frequency. Over the past month, the 10-year Treasury note’s daily yield range has exceeded 15 basis points 10 times, three of those in July.
The two-year note’s yield, more directly influenced by changes in Fed expectations, has had daily moves exceeding 20 basis points eight times, including on Wednesday. It climbed from near 2.75%, the lowest level in more than a month, to 3% after stronger-than-expected economic data and minutes of the Fed’s June meeting, which said policy could become “even more restrictive” in time.
The volatility trend has surprised investors, many of whom believed it would ebb as rates did because they’d be closer to the zero bound, Barclays Plc strategist Amrut Nashikkar said this week. That mathematical fact has been overshadowed by a range of potential outcomes that has widened since the Fed sharpened its rhetoric on inflation, he said.
“Central banks are clearly on a mission to restore price stability, regardless of any short-term costs for financial markets and the real economy,” Dario Perkins, global macro strategist at TS Lombard, wrote in research. “This is a new monetary regime for investors, because it means we have moved from a policy of ‘whatever it takes’ to one of ‘whatever it breaks.’”
The prospect of an economic recession was highlighted this week by the re-inversion of a key segment of the Treasury yield curve. Two-year yields rose more than 10-year yields and wound up higher, a rare occurrence that amounts to an expectation that the shorter-maturity rates will be lower in the future. It’s consistent with market-implied inflation expectations, which this week declined to the lowest levels of the year for the five- and 10-year time frames.
While the slope of the curve may steepen next week as longer-term yields face upward pressure from a series of Treasury auctions including 10-year notes and 30-year bonds, short-term yields offer relative safety in the meantime.
“The goal is to be aware of macro sensitivities to the broader economy and at the same time not be so dependent on the destination of the Federal Reserve,” said Jerome Schneider, head of short-term portfolio management and funding at Pacific Investment Management Co. “You don’t necessarily need to take a lot of interest-rate risk to get healthy compensation over the next year.”
By Michael MacKenzie and Liz Capo McCormick
