Whatever occurred to the knowledge of the bond market? | USAEMALL.com

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The bond market has lost its cool. And it’s not coming back any time soon.

The latest flip-out came earlier this summer, when one iffy jobs report from the US briefly opened the jaws of hell across all major asset classes. July’s non-farm payrolls report did clearly fall shy of expectations, with the US adding 114,000 jobs over the month, against expectations for 175,000. It was a big miss, making the argument that maybe US interest rates have been held too high for too long. But it was just one report, with some potentially problematic weather-related effects built in; and in any case, trying to predict payrolls accurately and consistently is a fool’s errand.

But government bond markets, and the suite of derivatives pegged to them that help investors hedge against or profit from moves in interest rates, nonetheless went bananas. At the peak of the summer shake-out, which has now mercifully passed, these markets were suggesting an expectation among investors that the US Federal Reserve might have to cut interest rates between meetings — an emergency step typically reserved only for the direst of crises like pandemics or financial stability shocks.

Two weeks or so later, stock markets have largely regained their poise. Measures of equity market volatility have settled back down to the sleepy levels they have occupied for nearly a year. Bonds, however, have not calmed down in quite the same way, only now backing away from the idea of a supersized rate cut in the autumn.

This is a break in the script. In the informal pecking order of markets, short-term currency moves are widely regarded as guesswork, while stocks are subject to fads. The rates market is supposed to be where the real brains are, throwing out signals for other asset classes to follow and providing a thoughtful read on where the global economy and monetary policy are heading next. But, awkwardly, these bursts of excessive excitability are becoming increasingly common.

Towards the end of last year, for example, the supposedly wise and dependable bond market was telling us that the Fed was going to cut interest rates six, maybe even seven times in 2024, simply because the fiercest of the heat had died back from US inflation. Months later, September is just around the corner and we are still waiting for rate cut number one. 

Looking back just a little further, US government bond markets reacted violently to the demise of Silicon Valley Bank in the spring of 2023. It was a meaningful bank failure, for sure. But the rates market reaction again was severe enough to suggest investors genuinely thought an emergency rate cut might be needed. Again, it was not.

Why is the supposedly brainy bond market exhibiting memestock-like tendencies? Greg Peters, co-chief investment officer at PGIM Fixed Income, says shifts in market structure are at least in part to blame, and “will continue to produce outsized reactions and moves”. Signal-sniffing algorithms and the greater role of speculative funds are a recipe for jerky market conditions. A weaker post-2008 ability among banks to absorb shocks does not help.

Added to that, central bankers are just as beholden to the ebb and flow of economic data as the rest of us. Since the pandemic, forward guidance, where they feel able to give a sense of what is coming up next, is a thing of the past.

“A backdrop of data-dependent central bankers is ripe for creating market flare-ups, and the new market trading structure is the gasoline that turns these flare-ups into a full-fledged blaze,” Peters says.

That is why these incendiary events, disruptive though they are to stocks, corporate credit and even commodity prices, are here to stay.

Iain Stealey, at JPMorgan Asset Management, notes that this dynamic marks a break from the volatility-suppressing post-crisis years of low interest rates and official bond-buying schemes. Now, “you get a push and pull in the market, and the market is questioning central banks,” Stealey says. “It does seem to be that we’re hanging on every data point.”

For investors, it is hard to know which bond moves to take seriously and which are head fakes, the latter of which are often a golden opportunity for bond specialists who can spot a dip to buy or a spike to sell. 

What is clear is that the long period of bond-market stability, verging on tedium, is over. That was the exception, not this. Now, bond markets can throw tantrums as well as any other.

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