The big bond sell-off may have finally subsided this week, but a Treasury fear gauge sends a clear message: Since the global financial crisis, two-year Treasuries have not faced a such volatility risk.
In a week marked by safe-haven demand on Russian-Ukrainian tensions and the easing of bets on an outsized interest rate hike by the Federal Reserve, options traders lowered their expectations on developments. interest rates.
Implied volatility for short-term securities has fallen from staggering highs, but remains well above that of its counterparts for long-term rates, leaving a relative spread close to the extremes of 2009.
“That means there’s more uncertainty around key rates,” said Nancy Davis, chief investment officer at Quadratic Capital Management. “It’s a crazy time. Vol has a lot of leeway.”
High volatility is causing liquidity to erode in the Treasury market, where the Bloomberg U.S. Government Securities Liquidity Index — an indicator of yield spreads relative to a fair value model — is nearing US government highs. last year.
The spread is between a one-year option on a two-year interest rate swap – which on February 14 hit its highest level since 2011 – and a one-year option on a 30 years. The latter increased less dramatically, creating the largest gap in 13 years.
Over the coming week, US short-term rates will face a supply test in the form of Tuesday’s monthly two-year note auction. It looks likely to attract a yield of around 1.50%, the highest since December 2019. The January auction attracted 0.99%, and an increase of this magnitude has not occurred since 2004. The US week begins Tuesday after Monday’s holiday, leaving dealers with less time to prepare for the sale.
Longer-term Treasury rates were relatively stable last week, although the 10-year fell back below 2%. Yields across the curve remain at or near two-year highs as the Fed is set to begin a series of rate hikes to rein in the highest inflation rates in a generation. Implied price expectations for interest rate futures have risen to six quarter-point increases this year from three at the start of the year.
“I think it’s a pause here because the markets have appreciated a lot in a very short time,” said Gregory Faranello, head of US rates trading and strategy for AmeriVet Securities. “Geopolitically, it just throws another wrench into the equation,” he said.
Minutes from the Fed’s last policy meeting, released on Feb. 16, did not rule out a half-point rate hike, and the next meeting will be in mid-March.
Investors, however, doubt that the Fed can control inflation without triggering a recession. Last week’s changes steepened the Treasury yield curve between two and 10 years for only the second time this year, and between five and 30 years for the first time. Spreads remain close to their lowest levels for more than a year. Meanwhile, futures have started pricing in the possibility of lower rates by 2024.
“The market is facing a lot of uncertainty right now,” said Tom di Galoma, managing director of government commerce and strategy at Seaport Global. “That kind of put institutional investors on hold.”
What to watch
- Monday, US financial markets close for Presidents Day
- Economic calendar:
- 22 February: home price purchase index; FHFA home prices; S&P CoreLogic house prices; PMI Markit for manufacturing and services; Conference Board Consumer Confidence; Richmond Fed Manufacturing Index
- February 23: MBA Mortgage Applications
- February 24: Chicago Fed national activity index; applications for unemployment benefits; 4Q GDP revision; sales of new homes; Kansas City Fed Manufacturing Activity
- February 25: Personal income/expenditure and PCE deflator; durable goods orders; pending home sales; University of Michigan Consumer Sentiment
- Fed calendar:
- February 21: Governor Michelle Bowman
- February 22: Raphael Bostic, President of the Atlanta Fed
- February 24: Thomas Barkin, president of the Fed of Richmond; Bostic; Cleveland Fed President Loretta Mester; Governor Christopher Waller
- Auction schedule:
- February 22: invoices for 13, 26 and 52 weeks; 2 year tickets
- February 23: 2-year variable-rate bonds; 5 year notes
- February 24: 4 and 8 week invoices; 7 year tickets
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