In mid-March, as prices for U.S. Treasury bonds swung wildly following the collapse of Silicon Valley Bank, the trading desk at Legal & General Investment Management hit its top limits for both profit and loss several times in a single day.
"We'd be swinging from our profit-taking target to our loss tolerance level and back again, a couple of times within a 24-hour period," said Chris Jeffery, head of rates and inflation strategy at LGIM, Britain's largest asset manager.
That was just one example of how traders and their dealing models struggled to keep pace as worries about financial stability prompted a frantic repricing of interest-rate risk which in turn triggered the fastest plunge in U.S. and European government bond yields in over 30 years.
Things are calmer now, but seven traders who spoke to Reuters, some heading rates desks at big global banks, said March's mayhem continues to reverberate, with fears of further volatility in traditionally stable bond markets muting activity.
Investors rely on government bond markets to translate central bank interest rates into a stable benchmark for borrowing costs, from corporate loans to household mortgages. Any instability can tighten credit conditions and raise risks of a sharp economic downturn.
Bonds can be volatile, acknowledged LGIM's Jeffery, citing sharp, fast moves in Italian, UK and emerging market debt within the last decade.
"The difference here," he added, "was it was the U.S. Treasury market" - the $22 trillion bedrock of the global financial system, where yields typically move just a few basis points a day. On March 13, U.S. and German two-year yields saw a daily fall of 50 bps - a scale not seen in decades.
"I've been trading for 30 years and I don't remember fixed income markets moving this fast," said Pablo Calderini, chief investment officer at Graham Capital Management, describing the size and speed of the market action as "something that should rarely, if ever, happen".
Some asset managers described emergency weekend meetings to prepare for what might come next.
Yield shifts in government bond markets have become bigger - occasionally hitting 20 bps a day - since central banks started ramping up rate hikes last year to tame surging inflation.
The woes in the banking sector, including Credit Suisse's takeover by rival UBS, have further clouded the rates outlook, leaving government bonds vulnerable to further price swings.
The traders said they were braced for more market ructions.
Shares in troubled U.S. lender First Republic Bank hitting a new record low this week and a looming showdown over the U.S. debt ceiling suggest volatility will continue.
In March, investors also expressed concern about tight liquidity in government bonds, which can traditionally be bought and sold with ease.
A gauge of volatility in the Treasury market, the MOVE index, remains elevated although it has come down after hitting its highest levels since 2008 in March (.MOVE).
Policymakers cannot afford to ignore extreme swings in government bonds. Britain's central bank was forced to intervene in September when a bond rout exposed vulnerabilities in the pensions sector, threatening the stability of the financial system.
Bruno Benchimol, Credit Agricole's head of euro zone government bond trading, said that because markets moved so strongly in March, it had been much harder for dealers to take advantage of the volatility than during previous crises.
LACKING CONVICTION
After March's surge, April trading volumes in German bonds were below the average for 2022 and early this year, data compiled by MarketAxess for Reuters shows.
"You've gone back to normal functioning in terms of markets, but you just haven't gotten back to normal levels of conviction and risk transfer because the macro (environment) is not clear," said Snigdha Singh, co-head of fixed income, currencies and commodities trading for EMEA at BofA.
Citi's head of euro linear rates trading Zoeb Sachee said bond traders were at a "crossroads", unsure whether central banks would deliver more rate hikes to curb inflation or hold off to avoid creating financial stress.
Heads of fixed income at big asset managers said they were much less confident betting on rates, affecting the degree of risk they were willing to take on.
Pricing for each upcoming Federal Reserve meeting reflects a distribution of cuts, hikes, and no change, said John Madziyire, head of U.S. Treasuries and TIPS at Vanguard.
This meant he was reducing the risk he was taking on a daily basis, Madziyire said, adding he found it harder to trade $100 million of 10-year bonds "because no one wants to be locked into a $100 million position".
Jeffery said LGIM had reduced positions it takes in shorter-dated Treasuries by some 30% to maintain the risk level its funds tolerate.
Investors are also trying to protect their portfolios from further shocks, traders said.
They said the March moves getting worked into risk models could limit activity from hedge funds - important bond market players who took sharp losses in March after being caught out by the speed of price moves, exacerbating overall volatility.
The U.S. Securities and Exchange Commission has said hedge funds and other parts of the shadow banking system should face greater scrutiny after the upheaval in Treasuries.
Credit Agricole's Benchimol said that at some recent European government debt auctions the difference between the average and the lowest price buyers paid has risen, a sign that investors - especially hedge funds - are buying less of the bonds than in the past.
NEW ERA
The cost of trading, measured by difference between buyer and seller prices, doubled at the height of the March crisis, traders said, although transaction costs have since come down to more normal levels.
Traders said they were not concerned about the long-term functioning of the bond markets, but warned they remain vulnerable to further bouts of extreme volatility, especially while the policy outlook is uncertain.
"If inflation continues to be stubbornly high, then we'll price out those rate cuts and we'll price in more hikes," said Citi's Sachee.
For some, March's turmoil is the latest sign of how post-2008 regulations constraining dealer balance sheets are affecting bond market functioning.
Others noted markets were leaving behind an era of low volatility for good as rates rise.
"We've been in a lower rate lower volatility regime for a very long time," BofA's Singh said. "So as we are normalizing, these episodes are probably going to be more frequent."
