U.S. Treasury futures negative convexity rises to near 20-year high; creator of the MOVE index warns of a "nightmare scenario"

Harley Bassman, the creator of the MOVE index for the U.S. Treasury market, warns that a little-noticed feature of the bond market could make the selloff more severe and push bond yields even higher. Writing in his Convexity Maven newsletter, Bassman said the risk stems from the way traders deliver bonds when futures contracts settle. He said the recent sharp jump in yields has hit longer-term bonds hardest, with the longest-dated bonds becoming the ones used to fulfill futures contract delivery obligations under the so-called "cheapest-to-deliver" rule. But those bonds also have higher duration, meaning they face greater downside risk when rates rise. To hedge that risk, fund managers may sell other long-term bonds before the contract expires, creating a mechanism that amplifies selling pressure when prices have already fallen. Bassman said negative convexity tied to bond futures meaning their unusually pronounced downside risk has risen to the highest level since 2007, and may have contributed to the bond market's latest round of selling.