Analysis: This time, bond investors think a Fed pullback is real

Thu Jun 13, 2013 3:07pm EDT
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By Karen Brettell

NEW YORK (Reuters) - This time, the Fed is serious.

That's the judgment of U.S. government bond investors who believe the Federal Reserve is close to paring back its $2.5 trillion, 4-1/2-year bond purchase program, and it's causing turmoil in the U.S. Treasury market.

Trading in Treasuries has turned notably more volatile in recent days and volatility may continue as traders try to adjust to a marketplace in flux.

In the last six weeks, benchmark 10-year U.S. Treasury note yields have surged to 2.19 percent, from 1.60 percent at the beginning of May.

As a result the market has seen a sharp outflow from bond funds and notable lack of demand in Treasury bond auctions. The fund outflows and the rise in volatility offer a worrying glimpse of how markets are likely to behave as the Fed works to scale back its enormous monetary stimulus of the U.S. economy.

"When you see the volumes and the movements developing in different markets, then it shows you that the transition from accommodation to tapering to eventual sideline and then subsequent tightening is going to have a lot of bumps in the road," said Steve Rodosky, head of Treasuries and derivatives trading at Pimco, which runs the world's largest bond fund.

Expectations for future volatility in the government bond market have also jumped. The Merrill Lynch MOVE index .MERMOVE1M, which estimates future volatility of long-term bond yields, jumped to 84.7 on Monday, its highest level in almost a year, from a multi-year low of around 50 at the beginning of May, to 79 on Thursday.

Fighting the Fed has long been seen as a losing strategy. After four years of record monetary stimulus, however, many investors are unsure of what to do when the Fed is not the primary driver of market moves.   Continued...

A view shows an eagle sculpture on Federal Reserve building, in Washington August 22, 2012. REUTERS/Larry Downing