Bonds are supposed to be boring to a certain degree, but this month has taken predictability and lack of excitement to a whole new level.
Implied volatility in Treasuries has fallen to a near record low. Bond yields have remained fairly steady. Trading volumes are down. And big Wall Street banks are girding for a highly disappointing quarter with respect to trading revenues.
Even worse, investors are running out of possible events that could shake the debt market out of its stupor. Maybe China? Much lower oil prices? A central bank policy error? Indeed, debt markets interpreted comments by European Central Bank President Mario Draghi on Tuesday as signaling the bank's desire to start tapering its asset-purchase program later this year. But on Wednesday, the ECB sought to communicate that the market was misreading Draghi's comments.
In other words, everyone ought to go back to accepting the status quo.
This malaise (which is pockmarked with investors warning that the calm cannot possibly last) comes with consequences:
1) It creates a challenge for investment banks, which have already spent years cutting staff in response to disappointing debt-trading revenues. JPMorgan Chase & Co. and Bank of America Corp. said last month that second-quarter trading was on track to drop at least 10 percent, in large part because of a lack of volatility in debt markets. Citigroup Inc. had a similar message this month.
On one hand, these big banks are prepared for a slowdown after years of disappointments and staffing cuts. But some wonder whether the banks will look to trim even more if this unexciting market persists.
2) It creates a challenge for money managers, who have to decide whether to simply follow the herd into risky assets or prepare for doom, possibly giving up returns when the market keeps chugging along. Meanwhile, investors are widely expecting bigger returns than many professionals deem likely, setting up a somewhat perilous situation where cautious money managers may end up getting penalized for their skepticism about the market.
3) It poses a dilemma for central bankers, who want to be consistent and predictable but don’t want the asset bubbles that grow during times of complacency. Federal Reserve officials had a rather tortured message for investors on Tuesday, with Chair Janet Yellen saying that asset valuations are "somewhat rich if you use traditional metrics like price earnings ratios." But in response to a question about whether she expects another financial crisis in the near future, Yellen said, "I do think we're much safer and I hope that it will not be in our lifetimes, and I don't believe it will be."
Fed Vice Chairman Stanley Fischer seemed a touch more skeptical of the current market safety, saying, “There is no doubt the soundness and resilience of our financial system has improved since the 2007-09 crisis,” but "it would be foolish to think we have eliminated all risks.”
So, Fed officials are worried, but not that worried? What's an investor supposed to do with that? It seems as if the Fed is poised to keep raising benchmark rates as long as it can, but the end neutral rate will probably be lower than in the past.
If debt markets remain in a deep slumber throughout the summer and beyond, there will be some significant consequences. Even if there's no near-term full crisis, there will be slower-moving pain that'll come in the form of lots of small cuts as firms try to survive.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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