(Bloomberg) -- The fragility of the U.S. bond market was fully exposed Tuesday as U.S. President Donald Trump’s tariff delay pushed rates higher and a ramp-up of tensions in Hong Kong helped pull them back.
The widely followed spread on the 2-year and 10-year Treasury yields went back to teetering on the edge of inversion, and a second indicator within swaps continued to flash a dire warning.
Implied volatility in one-month options on 10-year interest-rate swaps has shot up relative to its one-year options, signaling that far more turbulence is expected in the short-term than in a year from now. That’s making the term structure of volatility more inverted than anytime since the Treasury bond-market flash crash of October 2014.
“The possibility of something triggering an event that moves us toward a crisis is way higher now than it’s been in a very long time,” said Glen Capelo, head of rates for Academy Securities in New York. “The rates market is telling you it’s going to happen, it just doesn’t know what it is yet: whether it’s Hong Kong, Brexit, European banks getting hammered, or the global economy. The system is in a more fragile state than I’ve seen in a long time and it will likely be an obscure, second-derivative event that creates the next crisis.”
Capelo said the unwinding of large positions or accounts being forced to take risk down could spark the next major volatility event.
“My guess is that the trigger will be something that’s not on the radar,” he said. “The next problem will be centered around liquidity.”
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