fixed income: the difference in volatility of US rates shakes traders

The big bond sell-off may have finally subsided this week, but a Treasury fear gauge sends a clear message: Since the global financial crisis, two-year Treasuries have not faced a such volatility risk.

In a week marked by safe-haven demand on Russian-Ukrainian tensions and the easing of bets on an outsized interest rate hike by the Federal Reserve, options traders lowered their expectations on developments. interest rates.

Implied volatility for short-term securities has fallen from staggering highs, but remains well above that of its counterparts for long-term rates, leaving the relative spread close to the extremes of 2009.

“That means there’s more uncertainty around key rates,” said Nancy Davis, chief investment officer at Quadratic Capital Management. “It’s a crazy time. Flight has plenty of room to run.

High volatility is causing liquidity to erode in the Treasury market, where the Bloomberg U.S. Government Securities Liquidity Index — an indicator of yield spreads relative to a fair value model — is nearing US government highs. last year.

The spread is between a one-year option on a two-year interest rate swap – which on February 14 hit its highest level since 2011 – and a one-year option on a 30-year swap. . The latter increased less dramatically, creating the largest gap in 13 years.

Over the coming week, US short-term rates will face a supply test in the form of Tuesday’s monthly two-year note auction. It looks likely to attract a yield of around 1.50%, the highest since December 2019. The January auction attracted 0.99%, and an increase of this magnitude has not occurred since 2004. The US week begins Tuesday after the Monday holiday, leaving dealers with less time to prepare for the sale.

Longer-term Treasury rates were relatively stable last week, although the 10-year fell back below 2%.

Yields across the curve remain at or near two-year highs as the Fed is set to begin a series of rate hikes to rein in the highest inflation rates in a generation.

Implied price expectations for interest rate futures have risen to six quarter-point increases this year from three at the start of the year.

“I think it’s a pause here because the markets have appreciated a lot in a very short time,” said Gregory Faranello, head of US rates trading and strategy for AmeriVet Securities.

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