Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
Life comes at you fast. From this morning’s Bank of England Financial Policy Committee report:
US equities and the value of the US dollar had declined in Q1 as some investors reduced US dollar asset positioning. And following the US announcement on trade tariffs on 2 April, the prices of global equities, risky corporate credit, and commodities fell sharply. Market interest rates also fell and yield curves steepened. Market volatility rose significantly and the US dollar depreciated. Market functioning, in the light of exceptionally high volumes, has remained orderly. Notwithstanding these falls in asset prices, the risk of further sharp corrections remains high.
That landed in our inbox at 10:30am. And here’s the yield on UK 30-year gilts at shortly before pixel time:
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30 yrs are obviously particularly important and interesting because the UK issues a lot of them, in part because of their popularity among insurers and pensions funds using Liability-Driven Investment strategies. You can read more about that from Toby here.
They’re also, infamously, the asset class that got most blown up the in the mini-Budget aftermath. So how much trouble are they in?
Well, they’re moving more than their peers in other markets, which is never a good start. Plus. today has seen the biggest move since the aftermath of Liz Truss’s mini-Budget in 2022 (more on that here). Which, tbf remains a pretty steep wall to climb:
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What’s happening? Well, the obvious answer is that US Treasuries are up, so gilts basically have to move too. Again, read your Toby.
There’s also a possibility that the UK will have to cobble together some kind of fiscal response to Donald Trump’s tariff shock, which would involve more borrowing and more price pressure on gilts.
But that doesn’t explain why 30 yrs are specifically getting hit so hard. As TD Securities’ Pooja Kumra writes of this “glaring move”:
On every metric, 30y Gilts are cheap: 30y Gilts vs. UST/Bunds, 30y UK ASWs or 5s30s curve, the move has been striking. Key risk for trade remains illiquidity due to which we keep a wider stop.
She notes:
— Sell-off in long-end seems similar to move seen March 2020. Trigger was global funds liquidating all non-USD holdings as a move to rush to cash. Tracking our fund flows, long-end Gilts have been the key beneficiary of these flows. EPFR flows are still muted in Bunds and so there is less liquidation move.
— Growing presence of leveraged players in Gilt cash and repo market. A key risk flagged by the BoE members.
Once again, all simply roads may lead to Threadneedle Street. Markets are now pricing in far more Bank of England rate cuts, but this type of action might force the Monetary Policy Committee could move more quickly, Kumra suggests:
Markets should not underestimate a possible easing in the form of regulations or verbal easing or even temp QT freeze on this move.
We’ve said it before: it’s Andrew Bailey’s world, we just live in it.
Further reading: — Where the Bank of England’s QE programme went wrong
Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
Futures indicate that the US stock market could suffer another iffy day when trading resumes, putting it perilously close to bear market territory.
Goldman Sachs’ chief global equity strategist Peter Oppenheimer has therefore updated his bear market anatomy report, and made it public for Alphaville readers here.
After all, as Oppenheimer points out, not all bear markets are created equal, and its nature “has some bearing on the triggers, timing and speed of the recovery”.
Here you can see a full list of every US bear market going back to the early 1800s, how long they lasted, how deep they were and how long it took for stocks to fully recover (higher-res here):
As you can see, Oppenheimer sorts bear markets into three main categories: structural, cyclical and event-driven.
He reckons that we are now on the cusp of a classic event-driven one — triggered by the new American tariff regime — but warns that it “could easily morph into a cyclical bear market given growing recession risk”.
This matters most for how long it might prove to be. The damage tends to be roughly equal, but event-driven ones tend to be brief (and therefore perfect for dip-buying investors) while cyclical bear markets on average last two years, and it take about five years to fully recover the lost ground.
Anyway, there are lots of other interesting titbits in the full report, which you can read here.
Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
There has been a lot of tariff-related research and commentary hitting Alphaville’s inbox over the weekend. It can broadly be sorted into the good, the bad, the ugly, and the ARK Invest.
The email from the investment group’s head Cathie Wood starts out in classic everything-is-amazing-ignore-the-dumpster-fire ARK style:
While many observers fear that the Trump tariff policy is a recipe for economic and geopolitical disaster, we believe that what looked at first glance like the largest and most regressive tax increase in US history could turn out to be quite the opposite.
No notes. Almost as good as when Wood bragged about how ARK had incinerated so much money that it wouldn’t have to pay capital gains tax “for years”.
Wood then pivots to Elon Musk boosterism, and blaming Peter Navarro for what even she calls a “chaotic situation based on incomprehensible ‘reciprocity’ calculations”:
Now that President Trump has asked Treasury Secretary Bessent to take the lead from Peter Navarro and Howard Lutnick in negotiating with our allies, what once seemed like a chaotic situation based on incomprehensible “reciprocity” calculations could have been a setup — premeditated or otherwise — for serious negotiations that will lead to lower tariffs and non-tariff barriers, neither of which would have been possible without the shock therapy that President Trump administered. Still influential in the Trump Administration, Elon Musk has been a strong advocate for this solution to the tariff and non-tariff trade barriers that have evolved over the last 50 years.
More great stuff. Let’s ignore that Donald Trump’s pretty much only constant political lodestar has been an aversion to free trade and a love for tariffs. This was actually all a brilliant Art of the Deal ploy to ensure more international trade and lower tariffs.
Wood says her “working assumption” has been that President Trump wants a booming economy and stock market by the second half of 2025, ahead of the 2026 midterm elections. Well, sure, what president wouldn’t want that?
But she admits that the first half may be a bit tough:
Even before the tariff controversy, we had been expecting strong growth to begin sometime in the second half, because we do believe that the last leg of a three-year rolling recession will result in negative Gross Domestic Product (GDP) growth for the first and second quarters. During the past three years, as one cohort of the economy after another capitulated to the interest rate shock that started in 2022, high-end consumers and the government propped GDP up. Now, both are giving way, with the government entering its first recession in 30 years. As a result, the Administration and the Federal Reserve will have more degrees of freedom to stimulate than most investors have been expecting. Now that much of the economy has seized up in response to the fear of tariffs, the drop in activity is likely to be more severe than otherwise would have been the case, a clarion call for tax cuts, deregulation, and lower interest rates.
Look, there is actually an argument to be made that the extraordinary budget deficit that the US has been running has indeed flattered the American economy in recent years.
But blaming a recession on government spending cuts when Doge is mostly FAFOing on the edges and the deficit is actually at a record high is extremely desperate (yes the deficit was down 31 per cent in March, but that is mostly to do with the timing of benefit payments and tax receipts. About $83bn of benefit payments for March were actually paid in February because the month started with a weekend. Without this shift, the deficit would have increased 11 per cent in March.)
The US economy was actually pottering along quite nicely until recently, expanding at a roughly 2 per cent clip until Trump took over. The Atlanta Fed’s latest (gold-adjusted) nowcasting model now implies that we probably saw a 0.3 per cent contraction in the first quarter, and the second quarter is likely to be a mess:
A reminder that a mere year ago ARK forecast an average annual growth rate of 7 per cent until 2030 thanks to robotaxis, the blockchain and AI etc.
Further reading: — Which funds have incinerated the most value over the past decade? (FTAV)
Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
The US is learning a lesson in market maleficence as post-‘Liberation Day’ shockwaves continue to ripple through global markets. Today’s pain point is US Treasuries, and if they go, nothing’s safe. Not even Games Workshop.
So, is the surge in UST yields and dollar dip the arrival of America’s very own “moron risk premium” — the double discount on bonds and currencies that Britain incurred following Liz Truss’s infamous mini-budget?
No, says the guy who coined the term.
In a note just published, TS Lombard’s Dario Perkins says the US is “a long way from a Liz Truss moment”, pointing to the relatively smaller move in yields since The Event:
Sure, the vibes aren’t great, says Perkins:
For the first time in my career, I’m hearing widespread skepticism about the competency of US policymakers. This isn’t about politics. A lot of investors would welcome, for example, Scott Bessent’s vision for Rubinomics 2.0. And it isnt about “policy mistakes”. The Fed’s history is littered with straightforward errors. It is about recklessness. That is why many global investors are also making the comparison with the UK’s “Liz Truss moment”.
However, it’s the style and pace that really matters. Markets can often cope with things breaking slowly, but it’s a fast break that usually has knock-on effects, as the UK’s LDI crisis in 2022 showed. Here’s Perkins:
The scariest dynamic during the UK crisis was that bonds and sterling were selling off at the same time. That signaled a sudden loss of confidence among global investors. (Confirmed by my conversations with them at the time, and questions like “what the heck is going on in the UK?!”) Yields rose and the currency plunged. That was the dynamic at the heart of my MRP.
Encouragingly this is not the dynamic we are seeing in the US. We did get a brief taste of it, but — so far — there is still global confidence in the dollar. Watch the situation closely, especially given the tone among international investors. Attacks on the Fed, talk of Mar-a-largo accords, threats to foreign UST holders, massive (arbitrary) tariffs . . . these are things that could trigger a nastier mkt dynamic. And that would be the path to a blowout in the term premium and a proper dollar crash.
So, less moronic than Liz Truss at least. Reassuring.
Of course, one advantage the UK had was that, once the going got rough, the Bank of England could simply step in and depose Truss Truss was more or less obliged by pressure from her own MPs to keelhaul both Kwasi Kwarteng and then herself in order to restore (some) market confidence.
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George Saravelos, global head of FX research at Deutsche Bank, has been worried about the outlook for the dollar for a while. Recent events have not exactly calmed him down:
We are witnessing a simultaneous collapse in the price of all US assets including equities, the dollar versus alternative reserve FX and the bond market. We are entering unchartered [sic] territory in the global financial system.
Collapse is a bit strong, but it isn’t great that US stocks, bonds and the dollar are all gyrating lower lately. Notably, after a bounce over the past couple of days, the ICE dollar index is slipping again today:
With that in mind, here are Saravelos’s three main points, which we’ll quote at length given the heightened interest in the topic:
The market is rapidly de-dollarizing. It is remarkable that international dollar funding markets and cross-currency basis remains well behaved. In a typical crisis environment the market would be hoarding dollar liquidity to secure funding for its underlying US asset base. This dollar imbalance is what ultimately results in a triggering of the Fed swap lines. Dynamics here seem to be very different: the market has lost faith in US assets, so that instead of closing the asset-liability mismatch by hoarding dollar liquidity it is actively selling down the US assets themselves. We wrote a few weeks ago that US administration policy is encouraging a trend towards de-dollarization to safeguard international investors from a weaponization of dollar liquidity. We are now seeing this play out in real-time at a faster pace than even we would have anticipated. It remains to be seen how orderly this process can remain. A credit event in the global financial system that threatens the provision of short-term dollar liquidity is the point of greatest vulnerability which would turn dollar dynamics more positive.
The US administration is encouraging the sell-off in US Treasuries. The first order effect of current policy is of course the generation of a large negative supply-side shock that raises inflation and makes it harder for the Fed to cut rates. There is of course the bond basis trade that is being unwound. But there is something larger at play as well: a policy objective of reducing bilateral trade imbalances is functionally equivalent to lowering demand for US assets as well. This is not a theoretical consideration: the US has this week initiated trade negotiations with Japan and South Korea, with a specific reference to currency levels being a negotiating objective. It should not be overlooked that Japan is the largest official holder of US treasuries. An implicit negotiating objective of lowering USD valuations entails the possibility of the sale of US treasuries from the Japanese Ministry of finance. We argued two weeks ago that the whole Mar-A-Lago accord framework was flawed because it imposed fundamental inconsistencies in the desired economic objectives of the administration. We are now seeing those inconsistencies exposed in broad daylight.
Beware a trade war shift to a financial war. At the epicenter of the last few days’ escalation is the trade war with China. As our colleagues have highlighted China appears to be maintaining the optionality on weaponizing the currency while signalling a far more supportive domestic economic stance. With a 100%+ tariff on China, there is little room now left for an escalation on the trade front. The next phase risks being an outright financial war involving Chinese ownership of US assets, both on the official and private sector front. It is important to note there can be no winner to such a war: it will damage both the owner (China) and the producer (US) of those assets. The loser will be the global economy.
What could act as a circuit-breaker? Well, as we wrote this morning there’s already rising speculation that the Federal Reserve will have to act somehow to quell the turbulence in the Treasury market.
We imagine the Fed will be loath to bail out leveraged hedge fund trades (again), but Saravelos reckons that it may have “no other option” than re-starting emergency Treasury purchases if the disruptions continue to deepen:
This would be very similar to the Bank of England intervention following the gilt crisis of 2022. Ultimately, the Fed’s job would be to aid the accelerated de-dollarization dynamic we alluded to earlier in this piece.
While we suspect the Fed could be successful in stabilizing the market in the short-term, we would argue there is only one thing that can stabilize some of the more medium-term financial market shifts that have been unleashed: a reversal in the policies of the Trump administration itself.
Further reading: — America’s endangered ‘exorbitant privilege’ (FTAV)
Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
As we wrote overnight, there are growing signs of stresses in the bond market. It’s hard to say whether swap spread or basis trades getting liquidated is the biggest contributor, but Treasury markets are unusually and unnervingly turbulent.
At pixel time the 10-year Treasury yield has climbed another 9 basis points to trade at 4.35 per cent and the 30-year yield has risen 12 bps to 4.83 per cent — taking the rise for both from the April 4 low to about 50 bps.
This is not what should happen when other financial markets are in turmoil, and is eerily reminiscent of the scarier bits of the Covid-19 market meltdown. It’s just not a good thing when a market that is supposed to be the ultimate safe port in a storm is suffering from its own tempest.
As a result, markets are beginning to price in the possibility that the Federal Reserve will once again have to ride to the rescue. From Deutsche Bank’s morning note, with their analysts’ emphasis below:
Given the scale of the rout, that’s raising questions about whether the Federal Reserve might need to respond to stabilise market conditions, and we can even see from fed funds futures that markets are pricing a growing probability of an emergency cut, just as we saw during the Covid turmoil and the height of the GFC in 2008.
Unfortunately, Alphaville’s Refinitiv account is on the fritz so we can’t check out exactly how likely markets are indicating this is, but it’s very understandable given the myriad signs of stress in financial markets.
Some analysts are attributing the most recent Treasury sell-off to yesterday’s weak auction of three-year notes, which raises concerns that some big investors are becoming more reluctant to keep funding the US. That might bode badly for the auction of $39bn worth of 10-year Treasuries later today, and a 30-year auction on Thursday.
However, the fact that this is a continuation of a trend ever since Friday afternoon suggests that the bad-auction explanation is itself weak. To Alphaville, this smells more like leveraged hedge fund Treasury trades getting liquidated. As a Wall Street trader told our MainFT colleagues last night: “It’s a proper, full-on hedge fund deleveraging.”
We spent most of yesterday’s post explaining the by-now infamous Treasury basis trade, but it increasingly looks like the unwind of a popular swap spread trade could also be a major contributing factor.
As you can see, the spread between Treasuries and SOFR — the Secured Overnight Financing Rate that has replaced Libor as the dominant measure of overnight borrowing costs — has become pretty extreme. This reeks of some hedge funds getting walloped:
In short, here’s how we gather this trade worked (let us know if we’ve screwed something up in the comments though):
Because of various bits of post-GFC regulation, US banks are constrained in how many Treasuries they can hold. Meanwhile, cleared interest rate swaps are less capital-intensive, which has led to swap spreads — the difference between the fixed rate bit of an interest rate swap and the comparable government bond yield — to mostly stay in negative territory for many years. Here’s a good BIS explainer.
However, at the start of the year, a lot of people were getting excited by the prospect of the new Trump administration unwinding a lot of the post-crisis regulatory edifice. In February, Barclays estimated that the scrapping of the “supplementary leverage ratio” alone could create about $6tn of “leverage exposure capacity”, which would in particular help Treasuries.
As a result, hedge funds went long Treasuries and short swaps in the expectation that the spread would flip from being deeply negative to closer to zero. But the convergence trade only works with lots of leverage. And the recent volatility will have ratcheted up margins across the board, forcing some to unwind these trades. That in turn turns the swap spread even more negative, and leads to another round of margin calls, and so on.
Aaaanyways . . . Alphaville suspect that the Fed will be loath to unveil an emergency rate cut simply to bail out mega-leveraged Treasury arbitrage trades, like it did in March 2020. After all, that was a unique threat to the financial system. This is just them being positioned foolishly ahead of a tragicomically predictable tariff shock.
However, if Treasuries keep getting caned like this the Fed might have to do something, given how troubles in the US government debt market can easily ricochet elsewhere. As Deutsche Bank noted, this is “an incredibly aggressive sell-off”.
Yesterday our MainFT colleagues published an important story about some of the US government bond market’s weird behaviour lately, which, unfortunately, quickly got buried by the unending avalanche of other news.
Fortunately, it also helps explain why US Treasuries have gotten hit hard again today, despite the stock market dipping back down again on more bad tariff headlines. From Monday’s story, with Alphaville’s emphasis below:
US government debt sold off sharply on Monday as hedge funds cut back on risk in their strategies and investors continued shifting into cash during a third day of acute tumult on Wall Street.
The benchmark 10-year Treasury yield jumped 0.19 percentage points on Monday to 4.18 per cent, the biggest daily rise since September 2022, according to Bloomberg data. The 30-year yield jumped 0.21 percentage points, the biggest move since March 2020.
. . . Investors and analysts pointed in particular to hedge funds that took advantage of small differences in the price of Treasuries and associated futures contracts, known as the “basis trade”. These funds, which are large players in the fixed-income market, unwound those positions as they cut back on risk, prompting selling in Treasuries.
“Hedge funds have been liquidating US Treasury basis trades furiously,” said one hedge fund manager.
The sell-off has now continued into Tuesday, with the 10-year Treasury yield climbing 4.29 per cent at pixel time. That’s a pretty chunky move of 13 basis points on the day, and the 10-year yield has now see-sawed up 42 bps since its low on April 4. That’s pretty noticeable, given that “risk-off” remains the dominant sentiment.
As Bespoke Investment Group’s George Pearkes wrote in a report today:
While the historic reversal in stocks today that saw the market close near the lows down over 1.5% having been up more than 4% at the highs is concerning, the rumblings in fixed income feel far more problematic. Over the last two days, 30y UST yields have risen a brutal 35 bps. While that’s not an all-time superlative, it’s extremely unusual, in the top 0.4% of all 2-day moves for the long bond yield.
What’s much more unusual is the fact that this large surge in bond yields has come with stocks dropping. In fact, this is the largest two-day increase in 30y yields with stocks down at least 1.5% over the same span since 1982!
It’s always hard to disentangle market drivers, and there are probably multiple culprits behind the Treasury sell-off, such as a weak auction of three-year notes and the Treasury swap spread trade unwinding. But the Treasury basis trade appears to be a big factor behind the cracks in the US government bond market.
As many Alphaville readers will know, we are above-average interested in the Treasury basis trade, and have been ever since it scared the bejesus out of us back in March 2020. For the uninitiated, here’s a quick explainer of what the Treasury basis trade is, and why it’s potentially problematic.
Treasury futures contracts typically trade at a premium to the government bond you can deliver to satisfy the derivatives contract. That’s mostly because they are a convenient way for investors to gain leveraged exposure to Treasuries (you only have to put down an initial margin for the nominal exposure you’re buying). Asset managers are as a result mostly net long Treasury futures.
However this premium opens up an opportunity for hedge funds to take the other side. They sell Treasury futures and buy Treasury bonds to hedge themselves, capturing an almost risk-free spread of a few basis points. Normally, hedge fund managers don’t get out of bed for a few measly bps, but because Treasuries are so solid you can leverage the trade many, many times.
Let’s say you put down $10mn for Treasuries and sell an equal value of futures. You can then use the Treasuries as collateral for, say, $9.9mn of short-term loans in the repo market. Then you buy another $9.9mn of Treasuries, sell an equivalent amount of Treasury futures, and the repeat the process again and again and again.
It’s hard to get firm idea of what is the typical amount of leverage that hedge funds use for Treasury basis trades, but Alphaville gathers that as much as 50 times is normal and up to 100 times can happen. In other words, just $10mn of capital can support as much as $1bn of Treasury purchases.
And how significant is the trade in aggregate? Well, it’s an imperfect measure for a lot of reasons, but the best proxy for its overall size is the net short Treasury futures positioning of hedge funds, which currently stands beyond $800bn, with asset managers the mirror image on the long side.
The problem is that both Treasury futures and repo markets demand much more collateral when there is an unusual amount of volatility in the Treasury market. And if the hedge fund can’t pony up then lenders can seize the collateral — Treasury bonds — and sell them into the market.
As a result, it is a major danger lurking inside the market that is supposed to be the financial system’s equivalent of a bomb shelter, as Apollo’s Torsten Sløk pointed out earlier today:
Why is this a problem? Because the cash-futures basis trade is a potential source of instability. In case of an exogenous shock, the highly leveraged long positions in cash Treasury securities by hedge funds are at risk of being rapidly unwound. Such an unwind would have to be absorbed, in the short run, by a broker-dealer that itself is capital-constrained. This could lead to a significant disruption in market functions of broker-dealer firms, such as providing liquidity to the secondary market for Treasuries and intermediating the market for repo borrowing and lending.
We saw exactly how this latent vulnerability can morph into a systemic risk in March 2020, when a “dash for cash” by foreign central banks and bond funds swamped by investor withdrawals were forced to ditch the most sellable asset they had: US Treasuries. That in turn pummelled hedge funds that had put on monstrously leveraged Treasury basis trades, and threatened to turn a messy bout of Treasury liquidation into a cataclysmic financial crisis.
Only Herculean efforts by the Federal Reserve — its balance sheet expanded by $1.6tn in just one month — prevented it.
What happened late on Friday and on Monday is nothing near what we saw in March 2020, when for over a week the US Treasury market — the bedrock for the entire global financial system — came close to breaking. But as our colleagues pointed out, the volatility has been high, and that they sold off so violently yesterday is highly suggestive of at least some levered Treasury trades getting forcibly liquidated:
Many regulators and policymakers have been worried about the Treasury basis trade ever since, not least because the Fed’s actions constituted a de facto bailout of the strategy. That the basis trade has since swelled to become far larger than it ever was before March 2020 has understandably increased those concerns even further.
Unfortunately, doing something forceful about it is difficult precisely because the basis trade has become such a major pillar of support for the Treasury market, at a time when the US government’s borrowing costs have already ballooned.
As Citadel’s Ken Griffin noted back in 2023 — when the SEC’s then-head Gary Gensler had the strategy in his crosshairs — killing Treasury basis trade would “increase the cost of issuing new debt, which will be borne by US taxpayers to the tune of billions or tens of billions of dollars a year”.
So far it doesn’t seem like any basis trade liquidation is having a major disruptive effect on the Treasury market. What was scary in 2020 was both how yields moved up when they should be moving down, and how trading gummed up completely in an asset class that nowadays often sees about $1tn of trading a day.
That doesn’t seem to happened so far, even if Treasury yields moving higher on risk-off days like today is a little disconcerting. However, Bloomberg’s index of Treasury market liquidity (caveats!) has been a little loopy lately, so this is one to keep an eye on.
Further reading: — The debt-fuelled bet on US Treasuries that’s scaring regulators (FT) — The hedge fund traders dominating a massive bet on bonds (Bloomberg)
