Fears of instability in the U.S. banking system and poor liquidity were likely culprits of recent, extreme volatility in the world’s “safest bond market,” according to LPL Research.
The historically docile $24 trillion Treasury bond market erupted in volatility in March after the collapse of Silicon Valley Bank, evidenced by weekly swings in its policy-sensitive 2-year Treasury yield
TMUBMUSD02Y,
(see chart).
Extremes in the 2-year Treasury yield in March.
LPL Research, Federal Reserve Board 3/29/23
The LPL Research team pegged daily moves in the 2-year yield as averaging about half a percentage point, or 50 basis points, between the highs and lows each day, during the most erratic trading days in March.
They also said the “volatility in presumably the safest bond market in the world has been unprecedented,” in a Monday client note. Moves of only a few basis points a day would be considered more typical.
The 2-year Treasury rate
TMUBMUSD02Y,
swung to a one-year high of 5.064% on March 8, days before the collapses of Silicon Valley Bank and Signature Bank. The yield ended the month at 4.06%, its largest monthly decline since January 2008, according to Dow Jones Market Data.
In the wake of those bank failures, a group of researchers argued that sharply higher interest rates in the past year translated to about a $2 trillion decline in asset values in the U.S. banking system.
The Federal Reserve responded to banking jitters by rolling out an emergency facility for banks to tap for liquidity, with the aim of preventing forced sales of “safe” assets, including low-coupon Treasury and agency mortgage-backed securities that have fallen in value.
Concerns about the banking system were subsiding by the end of March, with U.S. stocks posting monthly gains. Stocks ended mostly higher on Monday, with the Dow Jones Industrial Average
DJIA,
and S&P 500 index
SPX,
getting a boost from a surge in oil prices.
See: Banks trim borrowing from the Fed for second straight week in wake of SVB failure
Traders in fed-funds futures kicked off April by slightly favoring another Fed rate hike in May, of 25 basis points to a 5%-5.25% range, after pushing up the odds of no increase to around 60% last week, according to the CME FedWatch Tool.
“We would advise investors to take advantage of any backup in yields and add high-quality fixed-income exposure,” the LPL team said.
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