(Bloomberg) – For bond traders, the uptrend in government bond yields has not been that difficult to predict. It’s the short-term fluctuations that are annoying.
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The world’s largest bond market is being rocked by its longest period of sustained volatility since the financial crisis began in 2007, in a stark break with the stability seen during the long era of historically low interest rates. And the uncertainty driving them doesn’t seem to be fading anytime soon: Inflation is still at four-decade highs, the Federal Reserve is aggressively raising interest rates, and Wall Street is struggling to gauge how well a still resilient one is economy is will hold.
The result is that wealth managers see no recovery from the turmoil.
“Volatility in fixed income markets will remain high over the next six to 12 months,” said Anwiti Bahuguna, portfolio manager and head of multi-asset strategy at Columbia Threadneedle. She said the Fed may pause its rate hikes next year, only to resume them if the economy is stronger than expected.
The continued volatility has sidelined some large buyers, pulling money out of a market grappling with its worst annual losses since at least the early 1970s. On Thursday, analysts at Bank of America Corp. warned that Treasury market liquidity — or the ease with which bonds are traded — has deteriorated for the worst since the March 2020 Covid crash, leaving it “fragile and vulnerable to shocks”.
After falling from June to early August, government bond yields have risen again as a key indicator of inflation rose to its highest level since 1982 in September and employment remained strong. These numbers and comments from Fed officials have led the market to expect the Fed to hike its interest rate to a peak of nearly 5% early next year after it currently ranges between 3% and 3.25%.
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The main data releases in the coming week are unlikely to change this outlook. The Commerce Department is expected to report that a measure of inflation, the Personal Consumption Spending Index, rose to annual growth of 6.3% in September, while the economy grew 2.1% in the third quarter, recovering from the contraction in previous ones three months recovered. Meanwhile, central bank officials will be in their self-imposed lull ahead of their November meeting.
Widespread expectation that the Fed will enact 0.75 percentage point for the fourth straight day on Nov. 2 has effectively raised questions about where monetary policy will head next year. There is still considerable debate about how high the Fed’s interest rate will eventually rise and whether it will push the economy into recession, especially amid rising risks of a global slowdown as central banks around the world tighten together.
Uncertainty was underscored on Friday as two-year Treasury yields rose, only to fall as much as 16 basis points after the Wall Street Journal reported that the Fed is likely to discuss plans to potentially slow the pace of its rate hikes after next month.
“If they pause after inflation comes down and the economy slows, market volatility will go down,” said Steve Bartolini, fixed income portfolio manager at T. Rowe Price. “The day the Fed pauses, volatility should come down, but we probably won’t go back to the low-volume regime of the 2010s.”
While the high volatility may present buying opportunities, any efforts to call a bottom were thwarted as yields drifted higher. In addition, investors are also aware that recessions and financial crises, which have historically followed excessive monetary tightening, have been associated with notable spikes in volatility.
That potentially means more pain for leveraged financial investments launched in a world of low inflation, interest rates and volatility, said Bob Miller, BlackRock Inc.’s head of Americas Fundamental Fixed Income. But for other investors, “there will be opportunities to take advantage of market dislocations and build bond portfolios with attractive returns of over 5%.”
Still, he expects price volatility to continue to plague the market. “Implicit volatility is clearly the highest since 1987 outside of the global financial crisis,” Miller said. “We won’t be going back to the experiences of the last decade anytime soon,” he said.
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