Wild moves in the $21 trillion US Treasury market have become disorderly. Shockwaves are pulsating through the international financial system and threaten to snuff out Europe’s economic recovery before it has even begun.
Central bankers have long been fretting over what might happen if incipient inflation and gargantuan debt issuance starts to set off an exodus from global bond markets. They had their first real taste late on Thursday. The cost of borrowing rocketed.
The US Federal Reserve in particular must navigate a narrow strait between the opposite perils of Scylla and Charybdis: damned if it does nothing, and allows the turmoil to continue; but equally damned it capitulates again, opts for easy stimulus to suppress yields, and falls even further behind the curve (in the eyes of bond vigilantes).
As matters now stand, the Fed has lost control over US monetary policy. Investors are betting that the overhang of excess M3 money created since Covid began will combine with the Biden Administration’s war economy stimulus - 13pc of GDP, including the pre-Christmas package - to lift the economy rapidly out of its long deflationary malaise.
Rightly or wrongly they are pulling forward an inflationary implication. Futures markets have priced in a full rate rise in 2022 and two more rises in 2023. This is self-fulfilling and will soon start rippling through financial contracts unless corrected.
Put another way, bond traders are dictating policy. They are tightening long before the Fed is ready or thinks that the coast is clear. So much for the charming idea of “running the economy hot”.
Nobody was spared on Thursday after investors shunned what was supposed to be a routine auction of seven-year US Treasury bonds, but instead sparked the worst bid-cover ratio on record (2.04) and a violent intraday spike of 30 basis points.
The spillover smashed into the vast Japanese bond market, where 10-year yields blew through the upper band of the Bank of Japan’s yield control regime.
Australia’s Reserve Bank had to intervene with emergency QE to hit its yield target. Junk bonds fell out of bed, giving up almost all the gains since vaccination euphoria began last year.
Equities have stopped rising in lockstep with bond yields for the first since the pandemic began. The Nasdaq bloodbath on Thursday was a sight to behold.
Ark Invest, the momentum ETF, is down 18pc over the past two days and is fast becoming a systemic threat in its own right, epicentre of a nexus of leverage. Saxo Bank warned that the “Tesla-Bitcoin-Ark risk cluster” could set off a toxic feedback loop that sucks other interlinked tech stocks into a downward vortex.
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