Investors sharply increased bets that the Federal Reserve will cut US interest rates this year in a frantic day of trading that weighed on markets.
The unrest was such that major US futures exchanges temporarily halted trading in some interest rate contracts. Risk-averse traders widened the gap between the bid and offer prices for US Treasury securities. Trades in the $22tn treasury market – the deepest and most liquid in the world – took longer and were more expensive to execute.
Wednesday’s market move came a week before the Fed is set to decide on interest rate levels at its next monetary policy meeting, following increases in months over the past year. Many bond traders now expect the Fed not to raise rates, though some still see a chance of a 0.25 percentage-point hike as it battles stubborn inflation, according to prices in the futures market. As recently as last week, markets were expecting a half-point hike.
Pricing in the futures market suggests the Fed could start cutting rates by a quarter point as soon as June and cut further to bring the central bank’s benchmark rate to 3.9 percent, more than 1 percentage point lower than expected. A peak of 4.9 percent in May.
Rate expectations have shifted after the failure of Silicon Valley Bank and two others in the past week fueled fears of a broader banking crisis.
The rapidly moving rate estimates caused price volatility that forced exchange operator CME Group to halt trading for two minutes in certain contracts linked to the sovereign borrowing benchmark and the federal-funds futures market. Trading has since resumed.
“There’s a circuit breaker that trips if those futures move more than 50 basis points, and that happened this morning,” said Tom Simmons, money market economist at Jefferies.
Traders said such a stop is rare, as interest rate futures tend to move in small increments based on signals from Fed and official data.
The yield on the two-year Treasury note, which is more sensitive to interest rate expectations, fell 0.27 percent to 3.98 percent on Wednesday. It fell more than 5 percent last week in a move not seen since the late 1980s.
The 10-year Treasury note yield fell 0.21 percent to 3.4 percent. Bond yields move inversely to prices.
“Some market participants were looking for the Fed to continue hiking until something breaks. Now the question is, was this it? Michael Dee Pass, global head of linear rate trading at Citadel Securities, said, referring to the sale of the bank.
The swings in the Treasury market were so large that the spread between bids and offers for Treasuries was wider, making it more difficult to buy and sell securities.
“Liquidity is tight and likely to worsen,” said Michael Lorizio, fixed-income trader at Manulife. “It makes sense that bid-ask spreads have widened, given the volatility.”
Dealing costs have risen, although investors still say deals are possible. A portfolio manager said: “We do deals of any size over the phone and negotiate prices more carefully. Going to the screen to execute electronically is painful.”
While some of the shift in futures markets is tied to expectations for Fed policy, traders said it is also likely to reflect the unwinding of leveraged positions that have been building since the start of the year.
“Speculators were short on bonds,” Simmons said. “Now we have a dangerous event and it’s been a scramble to cover those positions.”
That build-up was reflected in data from the Commodity Futures Trading Commission, which in mid-February showed the largest ever short position in two-year Treasuries — a bet on higher rates. CFTC data is usually released weekly but has been delayed by a recent cyber attack on Ion Markets, a financial technology group serving the derivatives markets.
Rate expectations first began to shift late last week after concerns over the future of Silicon Valley banks rose. They fell further on Wednesday after Credit Suisse said its largest shareholder would not provide more capital to the Swiss bank.
Meanwhile, the US reported that producer prices fell 0.1 percent in February, against expectations for a smaller increase. Wednesday’s report tempered Tuesday’s news that US consumer prices continued to rise, with inflation data putting pressure on the Fed to raise rates further.
“If we take a step back, the Fed has done a fair amount in terms of hiking cycles. And you look at when the hiking cycle started, we’re now at a point where you really expect hiking effects,” said Citadel Securities’ D.