Market Insider

Hair-raising bond rout leads to possible capitulation

Global bond beatdown

This week's quick spike in bond yields may be over for now but a higher level of volatility is here to stay, strategists say.

A grueling bond market rout, led by the German bund, drove interest rates to eight-month highs and yields could now trade at a new higher range. While rates could continue to rise more gradually strategists say this rapid jump may have topped out temporarily. The 10-year reached a high of 2.42 percent Thursday before slipping back to 2.33 percent.

Strategists said the selling appeared to reverse when the German 10-year yield hit 1 percent earlier Thursday. Buyers also came in when the International Monetary Fund said that the U.S. should delay Fed interest rate hikes until next year.

"The price action is keeping people to the sidelines, confused and very anxious," said David Ader, chief Treasury strategist at CRT Capital. "You get to a level, and we stop selling off. Some buying comes in and all of a sudden, the selling stops and you go the other way."

U.S. 10-year Treasury yield

Ader said it appears yields are topping out for now and he expects the 10-year to trade in a range of 2 to 2.5 percent over the course of the summer.

"We had an almost 1 percent bund, and we just bounced," said Justin Lederer, rates strategist at Cantor Fitzgerald. "Between that and the IMF headlines about delaying a first rate hike to Quarter 1, the Treasury market has found some life and is trading extremely well. We haven't reached yesterday's levels and we're still down for the week but this is a better place to go into payrolls. It's been a feast or famine market."

Markets have been looking forward to May's employment data Friday for what it will say about labor slack and wages, important elements in Fed decision-making. A total of 225,000 jobs are expected, and the unemployment rate is projected to stay steady at 5.4 percent. Average hourly wages are expected to rise 0.2 percent.

Lederer said there may not be a big move in yields Friday, even if the number is better or worse than expected. Instead, a better number may cause the yield curve to flatten, meaning the short end yields rise faster than the long end, which have been most affected by German rates. That would be a sign that the market expects a Fed rate increase sooner rather than later.

The U.S. Treasury market has been tethered to Europe, as the European Central Bank earlier this year committed to an easy money policy, the opposite direction U.S. central bankers are expected to take. In contrast, U.S. Treasurys were higher yielding and relatively more attractive, so when Europe sold off, the U.S. went with it.

"The way things are now, everyone is in the same trade so ultimately when everyone was thinking the bund (yield) was going negative, everyone was long bunds and when it goes the other way, it's not a pretty trade," said Lederer.

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Traders say the rapid move in the U.S. market shows a detachment from fundamentals, and the move in Treasurys itself could take on a life of its own.

European yields shot up Wednesday, in part on an improving economy but also because ECB President Mario Draghi in comments Wednesday made no commitment to tame European rates.

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Bank of America Merrill Lynch strategists said in a note Thursday that they believe the yields on 10-year bunds and Treasurys were topping out, and that they are now bullish.

On Wednesday, the strategists said the bund yield could be getting close to a top on a technical basis, as were U.S. 10-year note yields. They said the U.S. 10-year yield could move deeper into the 2.366/2.429 percent range before falling back to a range between 1.957 and 2.161 percent.

They said Thursday that the move to 2.252 percent confirmed the topping out move.