The Newport Beach, California-based asset manager, which netted a 929% gain in the pandemic stock crash, is buying up policy-sensitive two-year Treasury securities. Last year Bhansali had a big bond short launched in the grip of the inflation chaos.

“Given so much political pressure on the Fed, they are tightening -- and are going to over-tighten,” says the executive at LongTail, which deploys leverage and options to make big market calls. “There’s a slow-motion train wreck going on.” 

These kind of growth-related fears whipsawed the Treasury market in May -- the first month of positive returns since November 2021, with 10-year yields tumbling to as low as 2.7% from as high as 3.2%. This month, the benchmark is trading in a narrower range around the 3% mark. 

To Rebecca Patterson at Bridgewater Associates, the great 2022 bond selloff is far from over as all signs still suggest inflation will prove relentless.

“Given our views on inflation and Fed tightening needs, we see it as possible that the 10-year Treasury yield rises further -- and we don’t rule out yields at 4% or even higher,” says Patterson, the chief investment strategist at the world’s largest hedge fund.

Monetary officials are expected to deliver two half-point hikes at the June and July meetings, with traders pricing in more than an 80% chance of a third increase in September. All this is starting to work its way through the economy by denting consumer spending and sending the pandemic-era housing boom back to Earth. 

Leo Grohowski, for one, sees a disruptive tightening in financial conditions in the making that will create growth problems ahead, even as Fed officials seek to quash talk of a September pause.

“The potential for a policy error has begun to rise,” says the chief investment officer for BNY Mellon Wealth Management, who expects the 10-year security will close out the year at around 2.5%. “There is a risk the Fed is too hawkish and keeps tightening into a slowing economy.”

U-Turn
The Fed has U-turned before. In 2019, it loosened monetary policy after the damage inflicted on financial markets when it increased interest rates and shifted its balance-sheet holdings the previous year. In 2011, the 10-year yield closed the year below 2%, after peaking at around 3.75% in February as a slowdown in growth and the threat of a government shutdown suddenly boosted havens.

This time, unprecedented supply-side pressures are colliding with the economic aftermath of a pandemic, creating a fresh policy headache for Fed Chair Jerome Powell and his colleagues.