A maelstrom pulled bond markets apart on Thursday.
Even for an investment veteran like Gang Hu, the forced liquidation of popular operations in the Treasurys market midweek was one of the most violent in its career.
“What happened Thursday was a complete drought of the risk appetite in the fixed-income space,” Hu, managing partner and founder of hedge fund Winshore Capital Partners, said in an interview, adding that he has been sitting on the sidelines since last week. when the sell-off in the treasury markets started strong.
Hu was previously head of inflation trading at bond fund giant Pacific Investment Management, or Pimco, and his career has included a trader at BlueCrest Capital Management and a market maker at Credit Suisse.
His experience suggests that once bond sales, as in the past week, have picked up, the assessment of the appropriate interest rate based on economic and inflation forecasts does not matter where the short-term returns are heading.
“I told a co-worker of mine, ‘We sold the end of the sale for the seventh time, maybe it’s time to stop mentioning it,'” Hu recalled.
However, Hu says that valid concerns about a surge in inflation and an eventual tightening by the Federal Reserve this week have contributed to the huge sell-out of the treasury. But Thursday’s move was at least also the result of the downturn of market participants trying to downsize their positions to prevent them from being caught by further rapid market movements.
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The sharp rise in treasury yields on Thursday led to a sell-off in the stock market, which hit technology and other high-flying stocks the hardest and sent the Nasdaq Composite COMP
to its strongest loss since October. The Nasdaq bounced modestly on Friday as yields retreated, while the Dow Jones Industrial Average DJIA,
dropped nearly 470 points, or 1.5%. Key benchmarks ended the week lower.
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Part of the issue in the bond market was that market-based measures of inflation expectations could not hold higher trucks than predicted treasury yields were dormant, anchored by the Fed’s accommodative stance.
But traders were worried that if the price pressure rose as much as feared, the policy would have to sharpen up faster than it had planned, which would then curb inflation.
Those fears helped raise short-term rates, and contributed to losses in popular strategies designed to take advantage of an increase in price pressure. Shortly thereafter, market participants traded sharply like steeper yield curves, when traders simultaneously bought short-term Treasurys and sold their long-term counterparts to bet on a larger yield spread between the two maturities.
Finally, the evaporation of buyers and a rush of new stock on Thursday led to the worst performance in the 7-year treasury note TMUBMUSD07Y,
auction history since its reintroduction in 2009, the trigger for the ten-year treasury yield’s TMUBMUSD10Y,
short rise to 1.60%. The standard maturity rate dropped to 1.46% on Friday.
Primary traders left to pick up the unsold bonds, one of their responsibilities in exchange for the privilege of trading directly with the Fed, may have to temporarily increase returns to get rid of the bonds by the end of the day, Hu said.
‘I suspect that every transaction on Thursday was a risk reduction. Then the treasury had to issue so many bonds, but buyers were not willing to deal with it. Once [the auction] tail, then there was only pure panic from the traders, ”Hu said, referring to how the traders in the bond market described a poor result in an auction in the treasury.