Why US Treasuries are surprising investors

The moves seen in 30-year bonds are subject to structural forces that simply don't change overnight

A trader works on the floor of the New York Stock Exchange (NYSE) in New York, U.S., on Wednesday, Feb. 26, 2020. U.S. equities swung between gains and losses as investors digested fresh evidence of the widening coronavirus outbreak. Photographer: Michael Nagle/Bloomberg

In a week that has already been record-setting in financial markets by any number of measures, the moves in the 30-year US Treasury bond stand alone as jaw-dropping and unprecedented.

On Monday, the long bond opened at a yield of 0.99 per cent, down 30 basis points from where it closed the last trading session and the first time ever it fell below 1 per cent. About seven hours later, a relentless rally would push the yield to as low as 0.6987 per cent, a drop of 59 basis points that Bloomberg News’s Elizabeth Stanton noted was the largest intraday drop on record. During US trading, as equity markets plunged more than 7 per cent, the yield gradually pared back that drastic move, ending where it started at about 1 per cent.

On Tuesday, the long bond opened at 1.06 per cent. It would go on to reach 1.27 per cent by 7 am in New York and then, after a volatile session, reach as high as 1.3236 per cent as equities advanced almost 5 per cent.

All told, in the span of roughly 36 hours, 30-year Treasury yields surged 62.5 basis points from trough to peak. Measuring from the intraday high on March 6 to the low on Monday, the drop was a staggering 85 basis points.

Those sorts of rapid swings don’t happen to long-term Treasuries. I mean that literally. Two-day moves of such magnitude have never happened before since the Treasury Department began issuing the 30-year maturity in the 1970s. Bloomberg data began recording daily highs and lows in 1998. The 30-year yield rose 50 basis points in two sessions in February 1980 and fell 69 basis points in two sessions in November 2008, from 4.12 per cent to 3.43 per cent.

The reason it’s unprecedented is fairly straightforward. Thirty-year Treasuries are among the purest expressions of the long-term outlook for US economic growth, inflation and the path of interest rates available in financial markets. Those are subject to structural forces that don’t just change overnight. The Federal Reserve can deliver a surprise cut to interest rates, which can lower short-term Treasury yields in a hurry, but that traditionally has a more minor impact on the longest-dated securities. The assumption is that lower rates would stimulate the economy, leading to higher growth and inflation, which would eventually cause the central bank to bring rates back up again. The long bond spans multiple economic cycles.

The past two days of trading suggest that line of thinking might no longer hold. Here are a few scenarios that would explain why traders were piling into 30-year bonds with yields below 1 per cent:

1. The Fed will be stuck keeping its key lending rate at or near 0 per cent for the foreseeable future. There’s virtually no risk that the central bank will raise interest rates again out of fear that the US economy can’t withstand it.

2. Neither central bankers nor elected officials can stave off a recession that includes a period of deflation.

3. Foreign bond buyers see their home country yields remaining negative indefinitely and are panic-buying a safe, liquid asset that still offers a positive yield.

4. Speculators and momentum traders are riding the Treasury rally to its extremes.

5. All of the above.

I’m going to go with the fifth option.

After the violent sell-off in risk assets to start the week, Wall Street’s base case was for the Fed to drop the fed funds rate to the 0 per cent to 0.25 per cent range by mid-year. Even after Tuesday’s bounce, bond traders still expect chairman Jerome Powell to announce another 50-basis-point cut when the central bank’s meeting concludes on March 18, followed by another move or two in the coming months. At this point, it’s fairly obvious that the Fed can only shift interest rates in one direction. Mr Powell has made it clear that policymakers are not even considering the possibility of raising rates without seeing inflation persistently above their 2 per cent target.

That sort of price growth seems as unlikely as ever. Break-even rates plunged this week with oil prices after Saudi Arabia declared a price war. The risk now is disinflation or even outright deflation. With the fed funds rate already well below neutral, it’s also an open question what tools the central bank has, if any, to lift inflation back to target.

As for non-US investors piling into Treasuries, the big swings in Asian and European trading hours suggests that something is afoot. “Given the relevance of the overnight session in establishing the tone on Tuesday, our attention will be decidedly on the ability of any selling to extend in Asia,” BMO Capital Markets strategists wrote. Meanwhile, speculators increased their positions in eurodollars to a record net long in the week ending March 3 and were also bullish across 10-year note futures, according to Commodity Futures Trading Commission data. In bond futures, asset managers were the most long since 2010.

Given the market moves of the past few weeks and the barrage of headlines surrounding the coronavirus, it’s a fool’s errand to predict what will happen next. But the long bond seems to have been ensnared in traders’ doomsday scenarios. Maybe the Trump administration or Congress will unveil some sort of fiscal stimulus that lifts the markets and convinces Fed officials that they’re not the only adults overseeing the world’s largest economy. As my Bloomberg Opinion colleague Conor Sen wrote, bond buyers at these recent levels wouldn’t like that very much. And as he said: so what?

The long bond was never intended to be an ultra-volatile security that swings aggressively based on the whims of US stocks. And yet that’s what just happened. The iShares 20+ Year Treasury Bond exchange-traded fund suffered its steepest intraday decline on Tuesday since inception in 2002. On Monday, it climbed the most on an intraday basis since 2002.

The coming days could very well bring further bouts of volatility. It’s the sort of whiplash that’s enough to make even an ardent tracker of the world’s biggest bond market go numb.

Brian Chappatta is a Bloomberg columnist covering debt markets.