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Abnormal bond market move signals bears capitulating

A wild and historic move in the Treasury market Wednesday stunned traders and signaled capitulation by some investors who have been clinging to bearish positions.

The dramatic buying and big swing in rates coincided with a swift downdraft in stocks and was blamed on a combination of factors.

The weakness in Europe, worries Greece would exit its bailout, the possible breakdown of the AbbVie-Shiremerger, Ebola concerns, and weak U.S. retail sales data were all cited as factors for the jump in bond prices and slide in yields.

CBOE traders
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But one thing mentioned across the board was the end of the Fed's quantitative easing bond buying program in the next several weeks. Of concern is its potential impact on risk assets, at a time when global growth is in question and market expectations for the Fed's first rate hike are moving into the more distant future.

Traders said the market was pricing in a late 2015 rate hike, well past the midyear rate hike expected by many economists.

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The yield on the 10-year slid to 1.86 percent in a quick move down—its lowest level in intraday trading since May 2013before later reversing to 2.1 percent in the biggest one day move since November 2008, according to Jefferies.

"We've had our shock and awe short-covering rally, and all that, but something has changed," said David Ader, chief Treasury strategist at CRT Capital. He said the market will now look for a new lower range in 10 years, and will likely disappoint those who expected higher yields of 3 percent or higher this year.

"Today was the biggest volume day I've ever seen," said Ader, noting it was more than 2.5 times the recent average.

The move was a shocker, with many in the market expecting rates to go higher, not lower. Jeff Gundlach, CEO of DoubleLine, told CNBC just this week that he expected a 10-year yield of 2.2 percent to be the bottom of the range.

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"I think we're going to say this was one of those capitulative days and we'll have to figure out what the new range should be in 10s. We have learned a lesson about what central banks can do, and what they can't do, and I think that's what risk assets are telling you…they simply outpaced the economic scenario," Ader said.

The price move in the 30-year bond was also eye-popping, and a move unlike any since the 1980s, said Ader. "I don't remember the last time the 30-year bond moved in a six point range," he said. The low price was 102.95 and the high was 109.25, according to Reuters Tradeweb.

Some of the factors leading up to the move in Treasurys have been troubling markets for weeks but the market move was still a surprise.

"I think this day's unique. Other days like this were during periods of a continuum misery," said Ward McCarthy, chief financial economist at Jefferies. "It's not really clear what this was all about. It was a combination of the stock market looking toppy. This all really started with a surge in the dollar and falling commodities prices. It whipped around the globe and left its imprint on all the markets. When these types of things happened in 2008, it was because the world was collapsing and the U.S. was part of the collapse, but that's not the case right now."

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Cliff Noreen, President of Babson Capital, said the move into Treasurys is also prompted by low yields elsewhere in the world, such as Japan, and Germany where the 10-year yield was as low as 0.724 percent Wednesday.

"I think people are shocked by the level of yields being this low but QE is going," he said. "QE is old news and now we're dealing with what's going on (with rates) in Europe and Asia." There have been new concerns that the European Central Bank will not be forceful enough in its own easing program.

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"That's what's driving yields along with global slowdown fears. The 10-year should be trading between 4 and 4.5 percent, but that's not going to happen for a long time. We're in a global economy, and that's what you have to think about," Noreen said. Quantitative easing is the Federal Reserve's bond buying program which it has been tapering back since last year.

Noreen said the selloff in stocks was healthy. "What's really healthy today was the Russell really outperformed the S&P 500 and the Dow, and high yield market which is another indication of risk was down but not that much. Those two indicators were really important for the health of the markets and to help the markets stabilize. Large caps are really catching up with small caps."

Ader said he believes the Fed was the biggest reason behind the market moves.

"That retail sales number was not going to cause a 40-basis point move (in 10-year yield). This is a big positioning adjustment," he said. The markets had adjusted to Fed purchases of longer dated Treasurys and mortgage securities.

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"If the Fed is not buying those securities any more, all the asset classes that benefited from it now will go the other way. I think that was what we are dealing with now. The unwind of five years of asset accumulation and outperformance is going to be painful and we all knew it was going to painful. There's not a lot of liquidity out there and when you face that, it's a big deal. It's largely about the end of QE. It also tells you about positions. The positions were there for QE and are only now starting to come off," Ader added.

McCarthy said the markets are also trying to adjust to the unknowns that come with the end of the Fed programs. While he had expected rate hikes at the end of next year, others had not.

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"I think there has been some confusion about how the Fed would move along the path of policy normalization," he said, adding that the market is shifting its expectations out about six months. "The Fed is going to normalize on its own time frame. They're not going to be in a rush."

He said the commodities selloff is an indication of the weakness in the global economy, and the Fed will be driven by data. The Fed has also ballooned its balance sheet to more than $4 trillion with asset purchases since the financial crisis began.

"The Fed used to have one lever…Now they have two throttles. They have the balance sheet and the fed funds rate, and nobody has had experience of the interaction of the two at inflection points. The expectations that the Fed would go back to a neutral balance sheet and get back to normal had a lot to do with the dollar surge," he said.