Bonds

Executives speak on the uncertainty created by the Russia-Ukraine war and Federal Reserve announcements.

The surging volatility in the world’s biggest bond market is challenging traders trying to play both tighter global monetary policy and a war-induced commodity price shock that’s raising the specter of 1970s-style stagflation.

After a tumultuous week of big yield swings and heightened volatility in the U.S. Treasury market, investors are bracing for another hot inflation report, while the war in Ukraine increasingly casts a pall over Europe and the global economy.

“This puts the performance of inflation solidly back into the limelight” with the “risk that higher prices with the backdrop of heightened geopolitical uncertainty will ultimately be stagflationary.”

The Federal Reserve’s shift toward a major reduction of its footprint in the U.S. bond market this year has upended expectations for sustained cutbacks to the Treasury’s quarterly sales of longer-term debt, forcing dealers to gird for bigger auction sizes down the road.

Treasury yields rose a second day amid increasing conviction that the Federal Reserve will raise rates at least three times beginning in May.

In order to complete the monthly cycle of two-, five- and seven-year notes before Thursday’s holiday, the Treasury Department is cramming them into Monday and Tuesday, which hasn’t gone well in the past.

A majority of the 49 economists in the survey predicted the U.S. central bank will begin the taper in November and wrap it up by mid-2022, curbing the current $120 billion monthly buying pace by reducing Treasuries by $10 billion a month and mortgage-backed securities by $5 billion.

In a recent note to clients, JPMorgan strategists including Nikolaos Panigirtzoglou noted that inflation surprises are likely to persist into 2022 as supply bottlenecks and commodity price rallies continue.

If progress toward the Fed’s employment and inflation goals “continues broadly as expected, the committee judges that a moderation in the pace of asset purchases may soon be warranted,” the U.S. central bank’s policy-setting Federal Open Market Committee said Wednesday.

The timing of major upcoming shifts in Treasury supply and demand will be crucial in determining if the recent downward trend in yields continues or finally reverses.

Federal Reserve officials are moving closer to when they can start reducing massive support for the U.S. economy.

Consumer price spikes, which in June surged the most since 2008, will likely be a temporary feature of an economy that’s quickly recovering from the pandemic, said Federal Reserve Bank of San Francisco President Mary Daly.

But others warn that the optimism is unsustainable as a successful vaccine rollout doesn’t necessarily equate to the return of pre-pandemic work and travel habits.

U.S. government debt just logged its best week since August after the Treasury demanded the Fed return unused funds from emergency lending programs, a request the central bank said late Friday it would comply with. The development bolstered Wall Street predictions that the Fed will unveil more monetary action when it meets in mid-December.

Gross supply as of the end of June has already reached $1.2 trillion, a torrid pace considering the last decade has averaged $1.3 trillion per annum.

The Federal Reserve committed Monday to conducting more asset purchases of Treasury securities and mortgage-backed securities and announced $300 billion in new financing for credit facilities.

High-grade corporate bonds bested mortgages by a wide margin in 2019 and are likely to outperform them again this year, according to JPMorgan Chase & Co.

The federal government has opened a criminal investigation into whether traders manipulated prices in the $550 billion market for corporate bonds issued by Fannie Mae and Freddie Mac, according to people familiar with the matter.

Bank of Montreal is bundling uninsured residential mortgages into bonds in what could be the start of a new financing market for Canadian banks as the government scales back its support for home loans.