Posted by lplresearch
Tuesday, November 30, 2021
Financial markets tend to be relatively quiet the day after Thanksgiving but this year was a notable exception. With the news that a new COVID-19 variant—Omicron—had been discovered and is spreading quickly, prices of risk assets fell and safe-haven assets rallied on Friday. Within the U.S. Treasury market specifically, yields collapsed dramatically across the yield curve (yields fall when prices go up and vice versa) once again reasserting Treasury securities as safe-haven assets. As shown in the chart below, the yield on 10-year Treasury securities fell by more than 16 basis points (0.16%) on Friday, which was the largest one-day decline in yields since the COVID-19 lockdowns in March 2020. With this price action though, investors were left wondering if the bond market is signaling a return to COVID-19 induced lockdowns and thus a meaningful economic slowdown to follow.
“Bond markets are on edge right now. With a new COVID variant and potential changes in monetary policy expectations, we’ve seen rate volatility increase lately” noted LPL Financial Fixed Income Strategist Lawrence Gillum. “And these concerns are being exacerbated by poor liquidity in the Treasury market. Unfortunately, that means we’re likely to continue to see elevated levels of volatility in the near term.”
While it’s still too early to know the severity of the new variant and the economic implications, we think the bond market’s reaction on Friday wasn’t solely due to the Omicron news. While certainly serious, the Omicron news was likely exacerbated by poor liquidity in the Treasury market. As seen in the LPL Research Chart of the Day, the Bloomberg U.S. Government Securities Liquidity Index, which is an index that measures the prevailing liquidity conditions in the U.S. Treasury market (higher index levels equal less liquidity), shows that liquidity conditions in the Treasury market are the worst they’ve been since March 2020. As such, we caution reading too much into daily price moves, in either direction, as the Treasury market is currently set up to, frankly, overreact to news flow. We think the big move lower in yields on Friday was an example of this overreaction. That said, Friday’s directional price action within the Treasury market is a reminder that Treasury securities continue to be the best diversifier during equity market sell-offs and they still likely make sense within a diversified asset allocation.
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All index and market data from FactSet and MarketWatch.
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