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Volatile Bond Market Puts Traders on Defense Amid Fed-Cut Doubts
AInvestSunday, Oct 13, 2024 3:35 pm ET
2min read
THRO --
The bond market has been experiencing significant volatility in recent weeks, with traders adopting defensive strategies as uncertainty surrounding the Federal Reserve's interest rate policy increases. The combination of sticky inflation and weak labor market figures has led traders to trim bets on the degree of Fed easing left in 2024, driving yields to their highest levels since July. Meanwhile, a closely watched measure of expected volatility in Treasuries has risen to its highest level since January, reflecting investors' concerns about the market's direction.

The upshot for the bond market is that traders have tempered their rate-cut bets, with just 45 basis points of easing priced in for the next two Fed meetings, down from a full half-point of cuts expected prior to the September jobs report. Options flows have targeted just one more additional cut this year, while a more complicated options trade anticipates one quarter-point reduction followed by a pause in the easing cycle early next year.

The ICE BofA Move Index, a gauge of volatility that tracks anticipated swings in yields based on options, is nearing its 2024 high, indicating that investors expect little relief from the turbulence in the weeks ahead. Elevated rates volatility is likely to persist as investors await the Treasury's quarterly announcement for note and bond sales, the next monthly jobs report, and the Fed's Nov. 7 policy decision.

Asset managers, including giants like BlackRock Inc., Pacific Investment Management Co., and UBS Global Wealth Management, are advocating for buying five-year debt as a means of lessening vulnerability to a resilient economy, potential fiscal shocks, or turbulence around US elections. The sweet spot of five-year debt is favored because its maturity is less sensitive to such risks than its shorter or longer counterparts.

BlackRock's chief investment officer for the Americas, Solita Marcelli, suggests investments with medium-term duration, such as Treasuries and investment-grade corporate securities with about a five-year maturity. She recommends deploying excess cash, money-market holdings, and expiring fixed-term deposits into assets that can offer more durable income in a lower-rate environment.

In addition to favoring five-year debt, asset managers are also allocating funds between government and corporate bonds to balance risk and return. BlackRock and Pimco have been favoring intermediate-dated Treasuries and investment-grade corporate securities, as they expect the Fed to pursue a recalibration cycle from 5% to "getting policy between 3.5% and 4%," as long as inflation is cooling.

Derivatives and hedging strategies play a crucial role in BlackRock and Pimco's approaches to managing bond market volatility. These asset managers use options and other derivatives to protect their portfolios against potential losses and to generate additional income. By employing these strategies, they can mitigate risks and enhance returns in a volatile market environment.

As the election rolls into the window for option values, implied volatility will look higher, according to David Rogal, a portfolio manager in the fundamental fixed-income group at BlackRock. The firm continues to prefer intermediate-dated Treasuries, as it expects the Fed to pursue a recalibration cycle from 5% to "getting policy between 3.5% and 4%," as long as inflation is cooling.

In conclusion, the volatile bond market has put traders on defense as uncertainty surrounding the Federal Reserve's interest rate policy increases. Asset managers are favoring five-year debt and intermediate-dated Treasuries to mitigate risks and balance risk and return. Derivatives and hedging strategies are being employed to protect portfolios against potential losses and generate additional income. As the market awaits key economic data and policy decisions, investors must remain vigilant and adapt their strategies to the evolving landscape.
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