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Traders on Yield Watch in Bond Markets ‘Not for Faint-Hearted’

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(Bloomberg) — After last week’s market turmoil, there’s really just one question on traders’ minds: how central banks will react to the jump in bond yields.

The manner in which markets anticipate the likely policy response will be key to determining risk appetite Monday following a week in which 10-year Treasury yields, a benchmark for global borrowing costs, surged to almost triple their levels of August. The move underscored how investors are starting to fret about an acceleration in inflation that might prompt the Federal Reserve and other central banks to tighten policy sooner than expected. The S&P 500 had its first back-to-back weekly decline since October, while implied volatility in Group-of-Seven currencies rose the most since June.

“We are moving to a type of market condition that’s not for the faint-hearted,” said Nader Naeimi, the head of dynamic markets at AMP Capital Investors in Sydney, adding that he will continue betting against Treasuries. “The focus right now is the Fed and central banks. If they sound alarmed about the recent back-up in bond yields, then the curves will likely start flattening.”

As trading go underway Monday morning, yields on Australia’s 10-year government bonds slumped 19 basis points to 1.73%. Yield’s on the three-year benchmark eased half a basis point to 0.11%, versus the central bank’s target of 0.1%. In New Zealand, 10-year yields slipped 5 basis points.

The Reserve Bank of Australia waded in with A$3 billion ($2.3 billion) of unscheduled bond purchases last week in an effort to calm markets. Governor Philip Lowe may signal policy makers’ resolve to restrain borrowing costs at a policy meeting Tuesday. The country’s 10-year note yield climbed around 50 basis points in the week through Friday.

For all the recent whiplash in bond markets though, Friday provided some respite amid some month-end buying and attempts by policy makers to soothe markets. European Central Bank Executive Board member Isabel Schnabel said more stimulus could be added if the surge in yields hurts growth, while Fed Chair Jerome Powell called the run-up in yields “a statement of confidence” in the economic outlook.

The 10-year Treasury yield ended the week at 1.40%. It had surpassed 1.60% at one point on Thursday.

Still, investors will be looking for more reassurance in coming days as Powell delivers what are likely his final public comments before a mid-month policy meeting. A string of other officials are also scheduled to speak.

More Volatility

The volatility in Treasuries is “more than likely” to carry onto this week, said Marc Ostwald, chief economist and global strategist at ADM Investor Services in London. “Markets are still in the mood to challenge the Fed view of running everything hot.”

Mansoor Mohi-uddin, chief economist at Bank of Singapore Ltd., expects central bank officials to express more concern about the move in yields in coming days because tighter financial conditions may hurt the U.S. recovery.

“We expect the Fed to stop observing that surging yields are benign, for example by signaling it may delay tapering if bond markets remain volatile,” he said. “A shift in tone by the Fed would help stop 10-year Treasury yields rising further towards 2% in the next few months and instead stay at very low levels still to the benefit of risk assets.”

(Updates with opening of trading in Australia)

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