The recent violent selloff in the $20 trillion U.S. government bond market has eased, but it isn’t over.
Signs of stress are in fact everywhere; they imply that more such episodes of turmoil — or “tantrums” as they have become known — lie in wait over coming months.
Ten-year Treasury yields, the main reference rate for global borrowing costs, are now around 1.4%, having spiked last week to 1.6%, a whopping 130 basis point rise from March 2020 lows.
The brutal spillover into stock markets shaved $2 trillion last week from the value of global equities, which are trading on exalted valuations following a decade-long rally.
Volatility could return if U.S. economy continues to surpass expectations and President Joe Biden’s $1.9 trillion spending plan says Salman Ahmed, global head of macro at Fidelity International, noting “risks emanating from the impending fiscal dominance that will drive a notch-up in cyclical inflation”.
Here are some indicators that show bond market stress is by no means over:
1/ VIX TO FOLLOW THE MOVE?
The global bond slump boosted the volatility index to near April 2020 highs, but it contrasts with a similar index in the equity market which is trading half of the levels seen in April.
2/ WIDENING SPREADS
Signalling more stress for the bond markets is the widening bid-ask spread in U.S. Treasuries, an indicator of shrinking liquidity in the deepest bond market in the world.
Data from Tradeweb, a trading platform, showed wider spreads were a feature across the yield curve, pushing them to their highest levels since the March 2020 pandemic-fuelled selloff.
Graphic: U.S. 5-yr bonds bid-ask yield spread soars –
3/ EXPLODING TREASURY ETF TURNOVER
A major reason why spreads widened as volatility jumped has been a marked change in the composition of market participants in the bond market in recent years.
Traditional participants like banks have ceded market share to algorithmic trading in major markets with some estimates putting the share of algorithmic trading in U.S. Treasuries at nearly 90% compared to 50% at the start of the decade.
And as the computer-share driven trading models have become more widespread, turnover in futures and exchange traded funds have exploded while volume in cash markets have stagnated.
4/ NASDAQ-UST, A DEADLY COMBO?
A 60% Nasdaq and 40% US 10 year U.S. bond portfolio showed one of the largest bi-weekly declines since the global financial crisis.