At one time yesterday, the two-year Treasury—or the instrument most sensitive to monetary policy– was experiencing another 8 standard deviation move, the second such occurrence in three days. I do not know the odds of such occurring other than an eight standard deviation move occurs 0.000001%.
The catalyst for yesterday’s trading was Saudi Arabia’s comment that it will not invest additional capital into Credit Suisse for “regulatory and statutory reasons.” According to Bloomberg, Saudi Arabia owns about 10% of Credit Suisse and the Kingdom believes that it is not regulatory permitted to further increase its stake.
JP Morgan recently wrote Monday there was panic buying in the two-year Treasury as the short interest in the benchmark was “huge,” the result of Fed statements stating the overnight rate will be over 5.50% by year end.
Was short covering continuing?
There is rapid steepening of the yield curve, defined as short rates have dropped considerably from around a 5.10% yield on Thursday to around 3.90% yield yesterday. The 30-year Treasury has only dropped in yield from around 3.75% to around 3.67%. Many believe a portion of this steepening is not sustainable.
Writing it differently, the sharply inverted yield curve may no longer be a major part of the narrative.
Focusing on what is known, the bond market may be on the verge of a liquidity crisis, primarily the result of Dodd Frank which has severely limited money center banks to take risk based and market stabilizing positions. Dated Fed data indicate inventory positions are down about 90% from 2008 levels because of Dodd Frank and are believed to have dropped further.
Early yesterday there was an unexpected and unusual trading halt in a key corner of US interest rate market as futures contracts soared through circuit breakers, a halt that shocked most. Other pockets of the world’s deepest bond market may be starting to buckle under soaring trading volumes and wild swings as bank meltdowns force the market to slash rate hike bets.
In cash Treasuries, cracks are appearing in the rising spread between bids and offers across the curve, a distinct sign of thinning market depth and diminishing liquidity as bond market volatility soars.
Many believe the genesis of today’s potential liquidity issues is different than 2008. It is not about credit or composition of product, but rather about the ability to align sellers with buyers amplified by social media and algorithmic trading.
Fed Fund futures now place the odds at 50% of a 25 bps increase next week and have fully priced an overnight rate to be lower by 100 bps by year end.
All markets stabilized following the statement that Switzerland’s central bank will receive a liquidity backdrop if needed, the result of the Bank is regarded as “systemically important.” Treasuries reversed some of their gains.
Last night the foreign markets were mixed. London was up 1.03%, Paris up 0.79% and Frankfurt up 0.55%. China was down 1.12%, Japan down 0.80%, and Hang Seng down 1.72%.
Dow and NASDAQ futures are down 0.25% and flat, respectively. Credit Suisse is up about 20% on the loan from SNB. The 10-year is off 3/32 to yield 3.51% and the two year trading around 4.02% up about 5 basis points.