I don’t remember 94 this way

A widely circulated post to a Bank of England blog claims the bull market in bonds over the  past almost four decades has been among the three steepest in history, dating back to 1200.  That’s fun. As a Catholic, I am surprised to see the Roundheads were not more damaging.


But the post also claims that the 1994 “bond massacre” was due largely to technical influences, like (I would add) the Orange County fiasco and related convexity hedging. Here is the passage:

The 1994 “bond massacre” has attracted particular attention of late, and represents a second type of reversal, characterized by steep, but short-lived turbulence that is associated more with financial sector leverage and exogenous positioning – rather than macro fundamentals.

After bottoming in the autumn of 1993, US bond market yields started ascending quickly, even amid discount rates on a 30-year low. A rollercoaster performance followed, which saw bond volatility surge to levels not seen since the Volcker inflation fight. However, US bonds were firmly back in bull territory by 1995, adding 18.1% in prices after inflation.

Neither inflation expectations – which peaked at an unexciting 3.4%– nor fiscal policies, which remained on the steady Clinton consolidation path, offer satisfactory explanations for the rout. Though journalistic accounts link the sell-off with the Fed’s February 1994 decision to raise short-term rates, closer investigations suggest a loose correlation at best. As the data proves, volatility in US 10 year bonds started rising in Q3-1993, while official discount rates were only raised in May 1994 – at a time when volatility had almost peaked already (Chart 5).


The data proves? First of all, data are plural. Secondly, what he claims they prove is simply the data themselves. My being Canadian proves I am Canadian. Also, it is not even true. Vol continued to rise well after the Fed began raising rates. WTF?

I remember at the time a lot of people were telling that technical story, but it always struck me as strange — the noise around the bigger point.  The Fed raised interest rates 300 bps in early 1994, from a position of a flattish money market curve, because the economy was booming.

And the global demand for capital during that period was quite strong — or at least perceived to be quite strong.  You youngsters may not remember this, but back in 1994 people actually referred to a global capital shortage. I shit you not.  Guys on the street liked to imagine what would happen if everybody in China did a particular thing, not jump, but say buy a fridge or get a car.  There was no end to copper demand and the associated inflation pressure.

I was not quite so excited, but there seemed to me — at the time — to be a reason bond yields were rising, beyond just technical. (I wrote a US bond market strategy service publication at that time.)

More tellingly, after the bond debacle ended, the fed funds rate was adjusted only slightly downwards, the 10-year Treasury yield fell but not abruptly, and the economy remained very buoyant.  If bond yields had detached from economic fundamentals during the bear, then I do not imagine this would have been the aftermath.

But yeah, people said that at the time. I don’t think this guy has found some new perspective. I think he just has the old one, which I don’t share, fwiw.