Bond traders are bracing for wilder market swings in the US than in Europe, as signs the world’s largest economy is faltering fuel bets on a jumbo interest-rate cut from the Federal Reserve.
A measure of upcoming volatility in rates, or so-called swaptions, has risen in the US this week as weaker activity data boosted the view policymakers will lower rates by half a point later this month. In contrast, the equivalent euro-area gauge was little changed, with the European Central Bank widely expected to cut rates by a quarter point.
Investors have long considered the prospect of a larger-than-usual reduction from the Fed this year. But the chances increased markedly after data showed US manufacturing activity is contracting and as equity markets went into another tailspin led by Nvidia Corp. Traders now see about a 30% chance of a 50-basis-point move when the Fed sets rates on Sept. 18, up from 20% last week.
US Treasuries gained Wednesday, extending the previous day’s move. The two-year, among the most sensitive to Fed policy, outperformed, with the yield falling four basis points to 3.83%, the lowest in nearly a month.
For Michael Brown, a strategist at Pepperstone, the volatility in the US bond market is a consequence of how reliant the Fed has become on incoming data to guide its policy. “Such data-dependence can and does induce higher volatility,” he said. “Particularly at turning points in the policy cycle, such as the point where we now sit.”
It’s not only swaptions that are rising. The Cboe Volatility Index, dubbed the fear gauge, has jumped 50% this week as markets brace for the US employment report on Friday. Traders will also watch for signs of weakness in job openings and factory orders data due later Wednesday.
Fresh concerns over the state of the US economy have also left a key part of the Treasury yield curve on the brink of disinverting, a sign that the economy is already in the midst of a downturn and in need of policy support. The gap between two and 10-year yields has shrunk to just two basis points.
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