Last week we have seen bonds plunging to new multi-year lows with 10Y bund yield reaching almost 1.20% while 10Y Treasury paper touched 3.20%. However, this week bonds rebounded, and curves flattened due to higher risks of a recession. In this article we are looking at the major forces driving enormous volatility on rates.
After rising since the beginning of December 2021 with exception of a short period of risk off due to the Russian invasion, bond yields finally found support this week. Namely, on Monday we saw US10Y reaching 3.20% while the European benchmark almost touched 1.20% mark. Just to put things into perspective, that rise came after the worst quarter for bonds in history, and April in which yields on longer term global bonds went up by 50bps. However, equity markets kept losing their ground with many global indices being in a bear market and a significant number of tech names being more than 50% below their highs from 2021. There are several headwinds for equity indices with economic slowdown, high inflation, and higher interest rates being only the strongest ones. Nevertheless, for the most part of 2022, bonds were falling together with equities because markets had to reprice hawkishness of central banks and repricing was stronger compared to flight to safety bid. Nevertheless, this week correlation once again went to “normal” i.e., negative, with bonds rising while equities are falling. Bonds found support on Monday with flight to safety bid but also it could be that many market participants closed their short positions with massive gains.
On Wednesday, US Bureau of Labor Statistics published US CPI which showed that inflation is still above all expectations, with YoY data being below March but still at 8.3% while core inflation in MoM terms increased from 0.3% in March to 0.6% in April. Furthermore, the data showed that many core services’ prices showed acceleration and that inflation infiltrated in every part of the economy. Last week Fed decided to hike its rates by 50bps but decided to move 75bps from the table and markets quickly repriced rate forwards to exclude such hike. However, bearing in mind stubbornness of inflation there is a long way for Fed to think about bigger hikes in the future.
After the inflation data was published on Wednesday, bonds first fell sharply, coming close to their lows from Monday but closing above the opening. To be specific, 10Y bund yield opened slightly above 1.0%, rose to 1.10% after the data was published, and closed the day below 1.0%. And then yesterday we saw second biggest fall of yields this year, with bund yield falling towards 0.85%. So, the most important question this week is what was the driver of yesterday’s move? Most obvious is that economic slowdown is more and more priced and market bets that central banks will not be able to deliver such a strong pace of tightening without totally breaking the economy and will have to pause. Also, equity indices continued falling with SPX being below 3900 (high of 4818 on 4th of January 2022) being very close to bear market which pushed some investors to safer assets such as bonds. And last, yesterday we saw Finland saying it will apply to join NATO which could increase tensions between Russia and NATO and increase risk of nuclear war.
We already saw similar moves in bond markets at the beginning of March 2022 when EUR yields were negative once again. But after that, we witnessed one of the sharpest rises in yields on record. Volatility in bond markets is almost unseen and we expect bond markets to be very volatile as long as we have so much uncertainty on the plate.
Chart 1. RXA, 5-day period