On Monday this week, the world’s most important market went, to use a technical term, completely bananas.
Government bonds have a habit of rallying when the going gets tough, which they arguably did during the Silicon Valley bank collapse. So the US The subsequent jump in Treasury debt prices makes sense. The turmoil prompted nervous investors to seek safer havens.
The failure of SVB, and the hold of other regional US banks, suggests that the US Federal Reserve will remain more accommodative in its interest rates from here, fearing a slowdown in the banking sector. It may also mean that the central bank will not need to be as aggressive if commercial banks tighten lending standards. Both factors will boost the bond’s appeal. Also, many deposits were pulled out of banks and into US money market funds, where they were converted into Treasuries.
But there are bond rallies and there are bond rallies. This time, the market reaction to Treasuries was nothing short of apocalyptic. Two-year Treasury notes, the most sensitive instrument in the debt market to the outlook for interest rates, rose further in price. Yields declined by 0.56 percentage points, down from 0.31 percentage points the previous Friday.
To put Monday’s move into context, it represents a bigger shock than March 2020 — not a vintage period for global markets. It was bigger than any day before the financial crisis in 2008 (as well). You have to go back to Black Monday 1987 to find anything more serious. Trading volume was off the charts. It was Monday The greatest day For trading in Treasuries, the average is $600bn or more, with about $1.5tn changing hands.
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Yet at the same time, other asset classes barely broke a sweat. Some individual US bank stocks, as you might expect, slammed with a strong tech fan about them. But the S&P 500 benchmark index of US stocks ended flat. The picture is less clear, but similar, in Europe, where the Stoxx 600 stocks index closed about 2.4 percent lower on Wednesday — a decent hit, but not a disaster — while two-year German debt yields sank at their fastest pace. 1995.
All this tells you that something strange is going on in the bond market. Christian Cope, head of fixed income at Union Investments, points the finger of blame at the sector he previously worked in: hedge funds. The Treasuries market has become, he said, a “hall of mirrors,” with hedge funds trading blows with the Fed.
Macro hedge funds are flush with cash after the 2022 barnstorming, when they bet the farm on a rapid rise in interest rates and win. They have raised new money from investors willing to waive the fee for a piece of the action. They are exhibiting more muscle in the market than traditional asset managers like Union Investments, Kopf says.
As Kevin McPartland, head of market structure research at Coalition Greenwich, says, this is really hard to quantify. “The data simply doesn’t exist.” But the growing role of non-bank traders in the market is evident. Six years ago, banks trading with each other accounted for about 40 percent of the market, he says. It is now close to 30 percent.
However, for hedge funds and other types of speculators, the problem this week was that overall, they were running the same bets on 2023 as 2022, positioned to win in an environment where the Fed pushes interest rates higher.
When SVB started looking for safety in Treasuries, that bet paid off. When that happened, many hedgers were forced to close their positions, effectively making them buyers of Treasuries. It blew more negative bets, and forced more purchases. It was a classic short squeeze, and a big one at that. He has left a string of big-name macro hedge funds. “The world’s most important market is dominated by a conglomeration of hedge funds,” Kopf says.
However, yields are low. The Fed will not ignore the SVB disaster. Neither does the European Central Bank, which has banks cowering on its doorstep, even with Credit Suisse. “These events could very well lead to a recession,” said Tiffany Wilding, North American economist at Pimco. So far, the ECB has stuck to the script, opting for a half-percentage-point increase in rates this week. Yet it is reasonable to expect mild global rate hikes from here.
But at the same time, it’s worth cautioning before assuming that the bond market is throwing out reliable information about what the Fed and other central banks will do next. Market moves don’t necessarily mean investors actually think interest rates will drop anytime soon.
There is a bit of irony here. Part of the reason bond markets see more volatility now than they did a decade ago is that banks are safer, and less willing to hold on to risk, leaving hedge funds to fill the gap. But the past week has shown that fears over banks can still plague the world’s most important market, and the outside role of hedge funds can make a bad situation worse.
katie.martin@ft.com
