Bond traders wait for calm to shatter with Fed ‘breaking stuff’

CHICAGO – Bond traders are taking little solace in the market’s recent calm for a simple reason: It’s not likely to last.

Two-year US Treasury yields, some of the most sensitive to expected changes in interest rates, held in a relatively narrow range during the past week’s trading sessions, marking a reprieve from the volatility that erupted after Silicon Valley Bank’s collapse set off fears of a banking crisis. 

But the cross currents that have cast uncertainty over the market have not gone away.

Traders have

dialled up bets

that the Fed could raise interest rates in both May and June, threatening to delay the central bank’s long-awaited pause.

Angst is building that a political fight in Washington over the debt limit may not be resolved until the government is on the cusp of a default. And the economic outlook has been muddied by the prospect that banks will dial back lending to bolster investors’ confidence. 

“The volatility has really been in the two-year note, and it is a function of the fact that the Fed and other central banks are breaking stuff,” said Mr Gregory Faranello, head of US rates trading and strategy for AmeriVet Securities. “The Fed is trying to separate financial stability in the system and monetary policy – and I think that collides in May.”

The ICE BofA Move Index, which tracks expected swings in Treasuries as measured by one-month options, has tumbled nearly 40 per cent since mid-March, when it hit the highest since 2008.

Last week, two-year Treasury yields, which swung from as much as 5.08 per cent to as little as 3.55 per cent in March, ended at just below 4.2 per cent, up slightly on the week. 

Even so, swaps traders have ratcheted up the odds to about 20 per cent that the Fed will follow a quarter-point hike in May with another such move in June.

The reason: The economy is so far proving resilient, and inflation seems still far from receding rapidly back to the central bank’s 2 per cent target. 

While fear of a full-fledged banking crisis has ebbed since March, the tightened credit conditions that have resulted are providing a headwind to growth. That has raised the spectre of a slowly moving credit contraction that is muddying the outlook for monetary policy and bond yields. BLOOMBERG