Pockets of the world’s deepest bond market are starting to buckle under soaring trading volumes and wild swings as bank meltdowns compel traders to slash rate hike bets.
(Bloomberg) — Pockets of the world’s deepest bond market are starting to buckle under soaring trading volumes and wild swings as bank meltdowns compel traders to slash rate hike bets.
Trading was briefly halted in a key corner of the US interest-rate market Wednesday as futures contracts soared through circuit breakers. Signs of tension are building within US dollar funding markets. Liquidity has diminished in parts of the cash Treasury market after the collapse of three regional US lenders and amid rising concern about Credit Suisse Group AG’s financial health.
All together, it’s an indication of rising risk for US rates traders, who are once again ramping up bets that the Federal Reserve’s next move will be to cut interest rates.
An unusual two-minute trading pause shocked the market for key futures contracts used to wager on the Fed’s future rate moves earlier on Wednesday. The halts, which started around 9:14 a.m. in New York, added to mayhem across front-end rates, where the yield on two-year Treasuries tumbled as much as 54 basis points to 3.71%, the lowest level since September.
Stress was also evident in dollar funding markets as banking fears pushed lenders to shore up their own cash buffers in the wake of meltdowns at Silvergate Capital Corp., Silicon Valley Bank and Signature Bank.
In cash Treasuries, spreads between bids and offers increased across the curve, a sign of thinning market depth and diminishing liquidity as bond-market volatility soars.
“Liquidity is significantly compromised, following extremely volatile conditions, and indeed market depth remains at the weakest levels since late-March 2020,” JPMorgan Chase & Co. strategists Jay Barry and Jason Hunter wrote in note to clients Tuesday.
Market depth in Treasuries has become a recurring theme in periods of global financial volatility, with some bond experts concerned about the debt’s haven reliability.
Nonetheless, Treasury market functioning isn’t being compromised to the same extent it was in March 2020, as the lack of liquidity this time around is due to uncertainty over the Fed’s monetary policy path, JPMorgan’s Barry and Hunter wrote in the same note.
Futures Halted
Wednesday’s unexpected trading halts impacted June, July and August futures linked to the Secured Overnight Financing Rate, as well as Fed Funds futures for August and September.
The pause came as investors began pricing in a drop of more than 100 basis points in the central bank’s policy rate by year-end.
A spokesperson for CME, which operates the Chicago Mercantile Exchange where the futures trade, confirmed the dynamic circuit-breaker events and said the system worked as designed.
Circuit-breaker events are uncommon in rates markets, where price action can be exacerbated in times when liquidity tends to be thinner and gaps can appear between trader bids and offers.
According to Chapter 460 in the CME’s rulebook, trading is halted in three-month SOFR futures at a 50 basis-point move. The June 2023 contract traded around 95.74 as of 2 p.m. in New York. It triggered the brief trading halt earlier when it hit a session high at 96.11.
–With assistance from Marcus Wong.
(Updates to add additional comments from JPMorgan in ninth paragraph)
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