The deepest and most liquid fixed income market in the world is in deep trouble.
For months, traders, academics and other analysts have worried that the $23.7 trillion Treasuries market could be the source of the next financial crisis. Then last week, US Treasury Secretary Janet Yellen acknowledged concerns about a potential breakdown in government debt trading and said she was concerned about “a loss of adequate liquidity in the market”. Now BofA Securities strategists have identified a list of reasons why US government bonds are at risk of a “large-scale forced sale or external surprise” at a time when the bond market needs a group. reliable wholesale buyers.
“We believe the U.S. market is fragile and potentially at a shock from operating issues” resulting from either a “large-scale forced sale or external surprise,” said BofA strategists Mark Cabana, Ralph Axel and Adarsh Sinha. “A UST failure is not our base case, but it is an extreme construction risk.”
In a note released on Thursday, they said “we don’t know where this hard sell might come from,” although they have some ideas. Analysts said they see risks that could arise from mutual fund outflows, the unwinding of positions held by hedge funds and the deleveraging of risk parity strategies that have been put in place to help investors diversify risk across assets.
In addition, events that could surprise bond investors include acute year-end funding stress; a democratic sweep of the midterm elections, which is not currently a consensus expectation; and even a change in the Bank of Japan’s yield curve control policy, according to BofA strategists.
The BOJ’s yield curve control policy, aimed at keeping the country’s 10-year government bond yield around zero, is being pushed to breaking point due to rising interest rates and yields around the world. As a result, some expect the BOJ to change its policy, which was introduced in 2016 and is seen as increasingly out of step with other central banks.
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Right now, investors are grappling with a cauldron of risks: persistent inflation in the United States and around the world, accompanied by continued interest rate hikes by the Federal Reserve and other central banks, as well as as continuing uncertainty about the evolution of the global economy and financial markets. US officials are so concerned about the possibility of a repeat of the September volatility that gripped the UK bond market, that Fed and White House officials reportedly spent the past week asking investors and economists whether a similar collapse could occur here, according to the New York Times. .
Illiquidity in the normally functioning treasury bill market means that government debt cannot be bought and sold easily and quickly without having a significant impact on the underlying bond price – and this kind of situation would theoretically translate by problems for just about every other asset class.
Traders are only just beginning to factor in a greater likelihood that the fed funds rate target will rise above 5% next year from a current level of between 3% and 3.25%, raising the likelihood of continued bond sales soon after investors just wrapped up. head around a 4% level for interest rates.
From Thursday 2- TMUBMUSD02Y,
10-TMUBMUSD10Y,
and 30-year yields TMUBMUSD30Y,
pushed even further into their highest levels of the last 11 to 15 years. Rising yields dampened the appeal of equities, the three major US indices DJIA,
SPX,
COMP,
finishing lower for a second consecutive session.
.