Harley Bassman, founder of the US bond market's MOVE Index, warned that one feature of the bond market that has received little attention may make sell-offs more intense and further boost bond yields. Bassman wrote in his Convexity Maven newsletter that this risk stems from how traders deliver bonds when futures contracts are settled. He said that the recent sharp jump in yield has hit longer-term bonds the hardest. The longest term bonds have become bonds used to fulfill futures contract delivery obligations under the so-called “cheapest deliverable” rule. But these bonds are also longer-term, which means they face a greater risk of falling when interest rates rise. To hedge against this risk, fund managers may sell other long-term bonds before the contract expires, thus creating a mechanism to further increase selling pressure when prices have already fallen. Bassman said that the negative convexity associated with bond futures, that is, its unusually prominent downside risk, has risen to the highest level since 2007, and may be fueled by the recent round of sell-off in the bond market.

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