I agree with most of what Jamie Dimon, the head of JPMorgan Chase & Co., said about the Treasury market recently but I disagree that the gyration in yields that occurred on October 15 of last year was an “unprecedented move”. On March 18, 2009, the 10-year yield dropped an unprecedented 53 basis points. It could be that our sample so far is not representative of the population and such events are actually not rare.
First, let me start with what I agree from Jamie Dimon’s comments:
- The next financial crisis could be exacerbated by a shortage of the [Treasury] securities
- Bank regulations implemented after the 2008 financial crisis exacerbate price declines by limiting the ability of Wall Street banks to make markets
- It’s just a matter of time until some political, economic or market event triggers another financial crisis
- The industry is much stronger now because of higher capital requirements
However, I don’t agree with the following:
- Treasuries are supposed to be among the most stable securities
- The Treasuries move [on Oct. 15] was “an event that is supposed to happen only once in every 3 billion years or so”
Let us see why below:
The annualized standard deviation plot of the 10-Year Note yield from 1997 shows that this market is not as stable as expected. Wild variations in risk are an indication that stability of the Treasury market is only theoretical.
Furthermore, on October 15 of last year, yields changed by more than 16% from high to low but on March 16, 2009 and shortly after the financial crisis market bottom the change was more than 22%. Therefore, such wild gyrations are not rare events. The rarity assumption for these events is derived from applying the normal distribution but it is entirely possible that our sample so far is not representative of the population and the actual distribution has longer and fatter tails.
The chart of TLT below shows an even less rare picture for such events:
The event on October 15 of last year produced a gyration of 4.79% from high to low. Since inception there were three more events in TLT of even larger magnitude, as shown on the above chart. Therefore, the wild gyrations are not that rare and should be expected to occur. In addition, as the annualized standard deviation plot shows, Treasuries are a stable market only in college textbooks. In reality, there are high risks that at times even exceed those of the commodity and real-estate markets. Things may also get worse in the future as debt levels increase worldwide.
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