The tantrum in the bond market risks upsetting central bank credibility
The latest episode in the bond market is a puzzling one. While convexity hedging may be part of the reason that the belly is coming under pressure, this isn't one that is just purely a reflation/inflation story - all things considered.
The market is an interconnected entity but in times like these, one has to question whether or not the moves really make sense when taking things in as a whole.
We are seeing a global steepening in rates but it goes against a backdrop of different timelines playing out in the economic recovery across multiple countries and regions.
Not to mention the dovishness by major central banks, who have offered up constant reminders to the market that accommodative policy will stay on for a prolonged period.
That said, real rates have climbed significantly in the past two weeks and that raises a lot of uncertainty and jitters as to what the market is really trying to price in here.
For some context, 10-year real yields in the US have jumped by nearly 40 bps since the start of the month to its highest levels since June last year. And that is against the backdrop of breakevens sliding from 2.24% at the peak two weeks ago to 2.12% today.
As much as the Fed and ECB don't want to cause alarm by intervening too strongly (and obvious), they might be left with little choice if the rout intensifies and their credibility is called into question further down the road.
In fact, we might be seeing signs of that already by the ECB early today with European bonds seeing some bids at the open. Watch for the invisible hand today.
