Battered Bond Traders Have Another Dizzying Week to Prepare For

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Bond traders had better batten down the hatches again — after a brief stretch of relative calm, they’re about to contend with an array of crosscurrents, from quarter-end pressures to a torrent of dire economic data.

Ten-year Treasury yields swung 22 basis points last week from high to low, after four weeks when fluctuations averaged more than double that amount amid the turmoil fueled by the pandemic. The semblance of a respite came in part as stocks staged an impressive rebound from their nadir and as investors absorbed the Federal Reserve’s massive liquidity injections and the $2 trillion stimulus plan President Donald Trump signed Friday.

But the jury is out on whether equities have bottomed. And quarter-end brings fresh risks. The days ahead could trigger big shifts between asset classes because of investors’ need to rebalance, and potentially a resurgence of funding pressures despite the Fed’s efforts to tamp them down. There’s also the inevitable drumbeat of data showing the virus’s financial toll. The only question is how severe the job losses will get as the economy remains practically shuttered and authorities warn that infections will climb for weeks to come.

“The big volatility we’ve seen in both bonds and equities really has whipped people around and may cause some to move to the sidelines,” said Kevin Giddis, chief fixed-income strategist at Raymond James. With quarter-end approaching, “we are going to be pretty volatile going into that.”

The benchmark 10-year yield fell 17 basis points Friday, to 0.67%. The drop picked up in the afternoon as stocks slumped when the Fed said it will reduce the amount of Treasuries it will offer to buy as part of its efforts to improve liquidity in the world’s biggest bond market.

Last week’s Fed purchases helped the market absorb the $340 billion of Treasuries the government auctioned. This week there are only bills on the docket, with the debt likely to be sold at 0%. Bill yields in the open market trade below zero after the Fed slashed rates. Now there’s also fiscal stimulus to factor in.

A major challenge for investors is figuring out if it will all be enough to ease the economic pain. This week will surely bring a brutal stretch of figures. Releases on the manufacturing and services industries for March are expected to show contractions, and jobless claims may tally a fresh increase of 3 million, building on last week’s record 3.3 million filings.

“Massive government stimulus is dueling against the economic implications from the pandemic,” BMO Capital Markets strategists led by Ian Lyngen wrote Friday. “This tension is the primary debate among market participants.”

And then there’s quarter-end, which could at least briefly dash hopes for more normal trading conditions after some of the most severe dislocations in a decade. In a sign of how market functioning has improved, the spread between the bid and offer on the 30-year Treasury is well off its recent peak.

“The focus will be on the market returning to a healthier state and a normalization of the liquidity profile.” said Michael de Pass, global head of U.S. Treasury trading at Citadel Securities. “Exactly how the Fed’s involvement filters into Treasury-market liquidity is critically important. The Fed expanding its balance sheet at this rate will serve to dampen volatility and improve liquidity.”

Against that backdrop, the next few days will pose a test. The typical quarter-end strains are more worrisome than ever in light of this month’s volatility. JPMorgan Chase & Co. strategists predict that pensions and other investors will have to shift billions of dollars into equities to rebalance after the historic rout.

And the last few days of the quarter still may spark dislocations in repo markets even amid the Fed’s support for that crucial corner of the financial system. That’s because banks historically curtail activity during the period, causing outsized movements in borrowing costs.

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