The typically staid market for U.S. Treasury debt is a slumbering giant that is starting to stir. And over the coming days and weeks, some investors are worried that the rumblings could spill over into other markets, like stocks.
The coming weeks are shaping up to be a critical stretch for the $30 trillion Treasury market, widely considered the bedrock of the global financial system. Treasury bonds serve as vital collateral for short-term institutional liquidity, and Treasury yields set the benchmark borrowing rates for trillions of dollars in global debt, from mortgages to corporate bonds.
After climbing steadily earlier in the month, yields on long-dated Treasury bonds shot higher during the final week of July. Some interpreted the move as the market calling the Federal Reserve's bluff.
Since taking the reins at the Fed, Chair Kevin Warsh has talked tough on inflation. But investors are beginning to doubt whether he and his colleagues on the central bank's interest-rate-setting committee have the temerity to start lifting borrowing costs once again, even though the inflation rate has remained consistently above the Fed's 2% target for five years.
On Wednesday, three members of the Fed's rate-setting committee - all leaders of regional Fed banks - dissented from their colleagues, and voted to hike rates.
"Markets are questioning how committed the Fed is to bringing inflation to heel," said Gennadiy Goldberg, head of U.S. rates strategy at TD Securities.
By the time the dust had settled on Friday, the yield on the 30-year Treasury bond BX: TMUBMUSD30Y was trading at levels unseen since 2007. Meanwhile, the yield on the all-important 10-year Treasury note BX: TMUBMUSD10Y had broken higher, exiting a trading range that had held since late 2023, according to one analyst.
In the recent past, when Treasury yields have traded at or around these levels, the pressure has started to spill over into other markets, often weighing on stocks. Further underscoring the alarming nature of last week's rise in long-end yields: Crude-oil prices (CL00) (BRN00) moved lower, causing the correlation between oil prices and yields to further diminish.
"Hard to know how much longer other asset markets - particularly stocks - can stand rates at these levels without getting dragged down," wrote Bob Elliott of Unlimited Funds in commentary recently shared with MarketWatch.
As Warsh wrapped up last week's postmeeting press conference, yields on long-dated Treasury bonds suddenly broke higher, while yields on short-dated Treasury notes moved lower. This caused the Treasury yield curve - the gap between short- and long-dated yields - to compress dramatically. An analysis from Dow Jones Market Data showed it was the largest "Fed Day" compression of the yield curve since 2023.
As traders rushed to hedge against the possibility that rates would move even higher, the ICE BofAML MOVE Index, a measure of expected volatility in the Treasury market, started to tick higher and touched its highest level since May.
Demand for bearish put options tied to the iShares 20+ Year Treasury Bond ETF TLT also perked up last week, causing the ratio of trading volume between put options and bullish call options to shift higher, data showed.
Analysts at Cboe Global Markets said one-month TLT put skew - a measure of demand for out-of-the-money put options compared with out-of-the-money call options - surged to its highest level since the 2008 financial crisis.
That suggests traders are bracing for more fireworks in the Treasury market ahead - which isn't exactly surprising, according to TD's Goldberg.
"You've got all of this uncertainty around Iran, this uncertainty around Fed guidance to some extent. There's all sorts of other noise in markets," Goldberg said.
Late last week, the Treasury Department and Federal Reserve joined their counterparts in Japan in a historic coordinated intervention to help stabilize the flailing Japanese yen (USDJPY). The U.S. decision to join in the intervention was likely motivated by a desire to head off another outbreak of volatility in the Treasury market.
The coming days will include a handful of events that should help keep bond traders on their toes. More details on the Treasury's latest plans for financing the government will be released later in the week, and any surprise could unleash more volatility. Investors will also receive a handful of key economic reports this week, culminating with Friday's July jobs report.
"Our base case is we're not going to get a hike this year or next year - but the chances have materially gone up," Goldberg said.
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