ANALYST: My Readership Has Dropped By A Third Since The Bond Market Sell-Off


Back in January, there was some buzz about the “1994 scenario,” referring to the episode that year in which the Federal Reserve began tightening monetary policy as the economy improved, leaving a bloodbath in the bond market.

This year, the big bond sell-off didn’t begin until May, but by the end of June, the magnitude of the rise in bond yields that accompanied the selling was already outpacing that in 1994.

After topping out at 2.76% in July, the market has stabilised somewhat, and yields have headed back down to today’s levels at 2.53% as bonds have received some support in the marketplace.

Société Générale FX strategist Sebastien Galy says as we’ve headed into mid-summer and the sell-off has abated, he’s seen a sizable decline in readership.

And despite the support bonds have received recently, volatility still remains high, says Galy:

Activity and liquidity have dropped sharply. My readership dropped by a third, which is pretty much the loss of volume on the UST market according to my rates colleague. This is an environment where vol declines but to higher levels than you would expect as market makers with their depleted balance sheet don’t want to have to manage large short term positions. It is a tactical and technical environment where the market will try to trigger large stop losses given its higher impact.

BofA Merrill Lynch Head of U.S. Rates Strategy Priya Misra makes a similar point about volatility in a note to clients:

The other unique aspect of the sell-off has been a rise in volatility. It is remarkable that even though the market seemed to stabilise last week and imminent tapering is already priced in, volatility is still high. Volatility has been highly correlated with term premium and that explains why higher volatility has resulted in higher rates (Chart 1). Volatility was initially caused by the changed Fed response function.

The reaction last week to the FOMC minutes, Ben Bernanke’s Q&A and even to a well-known hawk such as Charles Plosser, tells you how skittish investors have become regarding the Fed’s response function. Further, duration shedding from the mortgage community as durations extended, central banks, and bond fund managers in response to outflows added fuel to the “volatility fire”. Until these technical factors subside, we do not expect volatility to decline much.

The next big focus for global markets this week will be Fed Chairman Ben Bernanke’s semi-annual Humphrey Hawkins testimony to Congress beginning on Wednesday. We could see more volatility.

“Bernanke will be a dove in his testimony and it will continue to surprise me that it is actually not fully priced in,” says Galy.

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