A 5 standard deviation movement

Escrito el 11 junio 2007 por Juan Toro en Financial Markets

A 5 standard deviation movement is how some analysts evaluated the movement in the bond market Thursday and Friday. Thursday’s and Friday morning’s joint 26bp sell-off in 10-year rates equates to a five standard-deviation movement (or a one movement every 7000 years). Last week sell-off was a true move for bond markets. In percentage terms it was a mere 3 % movement in yields, but the bond market is not used lately to suffer this swings. Normal question after this rout are: What triggered it? Will it continue? What are the consequences? Will it drag the stock market? Are we going back to a normal upwards interest rate curve where long maturities yield more than shorter maturities with inflation premiums? Will these higher borrowing costs affect the economy somehow? Many questions and also many guess floating around.

Let us try some answers to these questions. First, the triggering point of the sell off seems to be the poor productivity numbers released early in the week in the US, a new view on the state of the US/EU economies together with an unexpected interest rate hike by the Central Bank in New Zealand (CBNZ). Higher inflation expectations have been built over the last two weeks as both the US and EU economies have shown signs of strong recovery. In relation to the catalyst nature of the unexpected interest rate in New Zealand some might say that New Zealand is too little of a country (economically) and too far away (also economically speaking) to be considered a cause. This is true. But when all Central Banks join voices on inflationary pressures (as they did last week), and an unexpected action by a Central Bank is taken, no matter how small it is, this brings back memories of unexpected movements by the Fed. Just remember that the last easing cycle was initiated by an unexpected drop in the Fed fund of 50 basis points. Hence the movement from the CBNZ might have just brought to the mind of many bond managers a real possibility: an unexpected interest rate movement. The violence of the movement (25 basis points in two days) might have been caused by the natural overreaction on financial markets together with unexpected hedging needs (people taken on the wrong side, risk extension from some mortgage backed securities, convexity hedging needs


individual investor 21 junio 2007 - 06:33

i have to lean into the 3rd view you have where the few are. I follow a few folks and they side with the last opinion. As housing deteriorates, more and more, the economy will suffer, less consumer spending is already evident from Best Buy and Circuit City. the only inflation you see is in energy which hits the stores but people are buy in less or will be in the near future. These cycles repeat themselves. Don’t forget once China & India begin reporting slower growth, it’ll hit here quick.

Juan Toro 21 junio 2007 - 17:50

We are currently seen part of what you mentioned. Credit spreads are widening (housing slump) but the curve keeps steepening.

I disagree on your view that inflation is just energy related. What saved the CPI number on Friday (15th of June) was a stagnant rental market.

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