WILL THERE BE CHANGES IN BOND MARKET TRADING MECHANICS?

Are financial regulators finally acknowledging what every fixed income trader knows?  Yesterday regulatory officials met to address recent wild price swings in the Treasury market in an attempt to discern why such is occurring.

Bloomberg writes “traders already know the problem, that once again rules created in Washington by bureaucrats and perceived academic experts are having unforeseen consequences.”

The Volcker Rule limits banks from taking large proprietary positions in an attempt to reduce risk via the amount of bond inventory banks can keep on their books.  In times of QE, this was not a problem.

But now, partly because of rising inflation expectations and partly because of the start tapering, bonds have been falling as traders can’t hold and trade them the way they used to.  Bloomberg writes “given the biggest buyer of bonds since the financial crisis is slowing purchases, why would anyone else want them?  The Fed not buying bonds is defacto selling.”

The central bank is removing any limited liquidity and Bloomberg writes “it is not too smart to take them on given the dearth of potential large buyers”

The Newswire further opines this is the regulatory agencies own doing and “creating more rules to fix broken rules is not likely to help.”

How will this unfold?

As noted many times, the greatest element of all valuation models is cashflow discounted by a current and expected interest rate.

Commenting on yesterday’s market action, equites declined nominally on inflation fears. Oil fell about 2.5% as the Administration is considering a coordinated move with China and other countries to release crude from their respective reserves.  As noted several times, such a release only has a temporary impact unless the underlying environment changes.

Last night the foreign markets were down.  London down 0.17%, Paris up 0.14% and Frankfurt down 0.01%.  China was down 0.47%, Japan down 0.20% and Hang Seng down 1.29%.

The Dow should open flat.  Oil is also flat after China announced it will release crude from its strategic reserves, inviting the US to do the same.   The 10-year is off 3/32 to yield 1.61%.

 

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