Bond Yields Fall Biggest Since Volcker Era on Bank Fears

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(Bloomberg) — Monday’s shift in short-term interest rate markets was unlike nearly anything seen in more than four decades, which also included the 2008 financial crisis and the Sept. 11 terrorist attacks.

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The one- decline in two-year yields was the largest since the Volcker era in the early 1980s and surpassed the period around the Black Monday stock-market crash of 1987. At one stage they fell 65 basis points to 3.935%. , before going down about 61 basis points. Traders radically reconsidered their expectations for Federal Reserve monetary policy in the wake of multiple bank failures and the rollout of a new government backstop facility.

Monday marked the third-straight of a massive yield decline on the two-year note, bringing the total over that period to more than a percentage point. of all maturities rose in demand as investors continued to flee US bank stocks even after US regulators announced a rescue plan on Sunday evening.

The swap contracts referenced at Fed policy meetings — which endorsed a half-point rate hike at last week’s gathering of officials — reduce the odds of any hike from the current range of 4.5%-4.75%. The chances of a hike in the March meeting are now less than a couple of and the market is now suggesting the peak for this cycle will be at most a quarter point higher than where it is now. Meanwhile, remaining 2023 contracts suggest the Fed could cut rates by almost a full percentage point from the highest level in May before the year ends.

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“Today’s trade is owning the front end as financial conditions tighten with a poor outlook for riskier assets,” said Priya Mishra, global head of rates strategy at TD Securities. “The Fed wanted to tighten financial conditions, but not in a crippling way, so the price of some rate hikes is understandable.”

Mishra said that on the other hand, it is difficult to envision a rate cut as inflation remains high. Key inflation data for February – the Consumer Price Index – is due for release on Tuesday.

The reappraisal in rate-hike expectations reflects the view that financial stability risks will matter more to the Fed next week than inflation rates despite eight consecutive increases in the target band for the federal funds rate over the past year. is above its 2% target. ,

Economists at and Barclays rejected calls for a rate hike at next week’s meeting, with NatWest Group also predicting the Fed would reinvest its maturing holdings of and agency debt. Nomura went a step further, calling for a rate cut in March and an end to Fed quantitative tightening.

“A lot has changed over the weekend,” said Daniel Ivasin, chief investment officer at Pacific Investment Management Co. This is likely a multi-month adjustment process for the financial system.

Last week’s collapse of Silicon Valley Bank, the first US bank failure since 2008, highlighted the fallout from high interest rates, which prompted a dramatic tightening of financial conditions. Two other lenders, Silvergate Capital Corp and Signature Bank, also closed.

“Every time we see something like this happen, Treasury markets are heaven,” said Jack McIntyre, portfolio manager at Brandywine Global Investment Management. “It’s amazing if you’re positioned correctly and very frustrating if you’re not.”

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Yields in New York pared some of their losses shortly before midday. At the time, two Treasury bill auctions attracted much higher than expected interest rates, a sign that the rally scared off some investors. Simultaneously, a report that the US system of federal home loan banks was raising funds through a short-term note offering appeared to reduce demand for Treasuries.

heavy trading

Trading volumes were huge. Strategists at BMO Capital Markets estimated activity in was about 300% of the 10- moving average.

Less than a week ago the two-year note yield hit a multi-year high of 5.08% in testimony to Congress after Fed Chair Jerome Powell said the central bank would raise rates if economic data warranted. Was ready to pick up the pace again. Lowering the inversion of the Treasury yield curve, lowering long-term yields. The 10-year Treasury yield declined nearly 13 basis points to 3.57%, narrowing the gap on the two-years from more than a percentage point last week to about 40 basis points.

US regulators set up a new emergency facility on Sunday, allowing banks to pledge a range of high-quality assets for over a period of one year, and the lender also pledged to fully protect uninsured depositors. . SVB’s descent into FDIC receivership – the second largest US bank failure in history after Washington Mutual in 2008 – came abruptly on Friday after a few days where the tech startup’s long-established customer base pooled deposits.

Still, concerns are growing that the failure of the three banks may be just the tip of the iceberg.

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TD’s Mishra said the bank term funding program “prevents the fire sale of and mortgage-backed securities and helps with liquidity issues,” adding that the support “doesn’t solve capital issues, so it risks damages the properties and the treasury is a hedge against it.” He.”

(Updated throughout.)

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