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As we wrote overnight, there are growing signs of stresses in the bond market. It’s hard to say whether swap spread or basis trades getting liquidated is the biggest contributor, but Treasury markets are turbulent.
At pixel time the 10-year Treasury yield has climbed another 12 basis points to trade at 4.38 per cent and the 30-year yield has risen 15 bps to 4.86 per cent — taking the rise for both from the April 4 low to over 50 bps.
This is not what should happen when other financial markets are in turmoil, and is eerily reminiscent of the scarier bits of the Covid-19 market meltdown. It’s just not a good thing when a market that is supposed to be the ultimate safe port in a storm is suffering from its own tempest.
As a result, markets are beginning to price in the possibility that the Federal Reserve will once again have to ride to the rescue. From Deutsche Bank’s morning note:
Given the scale of the rout, that’s raising questions about whether the Federal Reserve might need to respond to stabilise market conditions, and we can even see from fed funds futures that markets are pricing a growing probability of an emergency cut, just as we saw during the Covid turmoil and the height of the GFC in 2008.
Unfortunately, Alphaville’s Refinitiv account is on the fritz so we can’t check out exactly how likely markets are indicating this is, but it’s very understandable given the myriad signs of stress in financial markets.
Some analysts are attributing the most recent Treasury sell-off to yesterday’s weak auction of three-year notes, which raises concerns that some big investors are becoming more reluctant to keep funding the US. That might bode badly for the auction of $39bn worth of 10-year Treasuries later today, and a 30-year auction on Thursday.
However, the fact that this is a continuation of a trend ever since Friday afternoon suggests that the bad-auction explanation is itself weak. To Alphaville, this smells more like hedge fund trades getting liquidated. As a Wall Street trader told our mainFT colleagues last night: “It’s a proper, full-on hedge fund deleveraging.”
We suspect that the Fed will be loath to unveil an emergency rate cut simply to bail out mega-leveraged Treasury arbitrage trades, like it did in March 2020. After all, that was a unique threat to the financial system. This is just them being positioned foolishly ahead of a tragicomically predictable tariff shock.
However, if Treasuries keep getting caned like this the Fed might have to do something, given how troubles in the US government debt market can easily ricochet elsewhere. As Deutsche Bank noted, this is “an incredibly aggressive sell-off”.