A whirlwind of sales destroyed the bond markets on Thursday.
Even for an investment veteran like Gang Hu, the forced reversal of popular trades in the mid-week Treasury market was one of the most violent of his career.
“What happened on Thursday was a complete depletion of risk appetite in the fixed income sector,” said Hu, managing partner and founder of the hedge fund Winshore Capital Partners, in an interview, adding that he has been sitting on the sidelines since the last week. when settlement on Treasury markets gained momentum.
Hu had previously served as head of inflation negotiations at bond fund giant Pacific Investment Management, or Pimco, and his career included stints as a trader at BlueCrest Capital Management and market maker at Credit Suisse.
His experience suggests that once bond market sales, like last week’s, began to roll, appropriate interest rate assessments based on economic and inflation forecasts did not matter where yields were going in short term.
“I said to a co-worker of mine, ‘We have closed the liquidation for the seventh time, maybe it is time to stop calling her,'” recalled Hu.
Still, Hu says valid concerns about rising inflation and an eventual tightening of the Federal Reserve contributed to the massive sale of the Treasury over the course of this week. But Thursday’s move, at least, was also the result of market participants retreating trying to reduce their positions to avoid being caught by new rapid market movements.
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The sharp increase in Treasury yields triggered a liquidation of the stock market on Thursday, which hit the technology sector and other stocks more strongly, sending the Nasdaq Composite COMP,
the biggest loss since October. Nasdaq jumped modestly on Friday with declining yields, while the Dow Jones Industrial Average DJIA,
fell almost 470 points, or 1.5%. The main benchmarks ended the week down.
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Part of the problem in the bond market was that market-based measures of inflation expectations could not continue to rise if the Treasury’s anticipated yields were dormant, anchored by the Fed’s accommodative stance.
But traders fear that in the event that price pressures increase as much as they feared, the Fed would have to tighten the policy faster than planned, which would contain inflation.
These fears helped to raise short-term rates, contributing to losses in popular strategies aimed at profiting from an increase in price pressures. Soon after, market participants broke up congested trades, such as those that increase the yield curve, when traders buy short-term Treasury bonds and sell their long-term pairs to bet on a broader spread of yield between the two maturities .
Finally, the evaporation of buyers and a wave of new offers on Thursday led to the worst display of the 7-year Treasury note TMUBMUSD07Y,
history of the auction since its reintroduction in 2009, the trigger for TMUBMUSD10Y of the 10-year Treasury yield,
brief increase to 1.60%. The benchmark salary rate dropped to 1.46% on Friday.
The primary brokers who were left to take over the unsold bonds, one of their responsibilities in exchange for the privilege of trading directly with the Fed, may have needed to temporarily increase yields to get rid of the bonds by the end of the day, Hu said.
“I suspect that every deal was a risk reduction deal on Thursday. So the Treasury needed to issue so many bonds, but buyers were not willing to deal with that. Once [the auction] then there was pure panic from the dealers, ”said Hu, referring to how the securities market brokers describe a poor result in a Treasury auction.