NEW YORK In the minutes before Wednesday's statement from the U.S. Federal Reserve, traders knew what to expect. Or so they thought.
Then came the surprise.
"No taper! No taper!" shouted a government bond trader on Schroders trading desk in New York, seconds after the Fed issued its statement, said Wes Sparks, head of U.S. fixed income at the firm.
That's when things got interesting - and in some cases, ugly - in the bond market. The 10-year benchmark Treasury's price shot higher, with buyers rushing in to cover wrong-way bets made in anticipation that the Federal Reserve would take baby steps to reduce its extraordinary support for the economy.
"People were scrambling to make sure they had all the information, trying to read the fine print," said Russ Certo, managing director and head of Treasuries trading at Brean Capital in New York.
"There were extreme distortions on how securities were being quoted, it was throwing people off. People literally weren't sure what handle certain securities were trading at."
Sparks said traders at Schroders tried to react as quickly as they could. "We were trimming some high yield bonds as they rose in price, especially the ones that kept pace with the rise in Treasury prices. And we were buying emerging markets," he said, noting that high yield bonds have outperformed emerging markets by about 10 percentage points this year.
Traders rushed to fill orders as volume built. The yield on the 30-year Treasury bond initially spiked to 3.88 percent, before falling sharply to 3.73 percent.
The 10-year note yield plunged to 2.69 percent from 2.85 percent, its biggest one-day drop in nearly two years.
More than 11.4 million interest rate futures contracts changed hands, according to CME Group data, compared with 6.8 million contracts the day before and an average of 6.1 million per day in August.
Mortgage bonds rallied, their yields falling sharply. A 30-year Fannie Mae note with a 3.5 percent coupon saw its yield fall to 3.35 percent from 3.58 percent.
Before the Fed meeting, polls of economists and investment managers showed a large majority thought the Fed was prepared to slow its $85 billion a month in bond purchases. A Reuters poll, for instance, showed 49 of 69 economists surveyed were targeting this week's meeting as the starting point for this policy shift.
At ING Investment Management in Atlanta, "so much anticipation had built up around the Fed's announcement that the surprising news of a 'no taper' decision really caught people's attention and created an urgency for everyone - from rates traders to corporate bond traders and high yield portfolio managers - to understand what was behind the Fed's thinking," said Treasury trader Jake Lowery.
Large speculators had amassed a short position of 85,000 contracts in 10-year Treasury bonds as of last week - slightly less than the previous two weeks, but still greater than at any other time dating to May 2012.
"There was immediate scrambling on the interest rate side and foreign exchange side," said Brad Bechtel, managing director at Faros Trading in Stamford, Connecticut.
"There was a very, very significant jump in volatility and volume and a mad scramble to correct portfolios as well."
Some in the market felt bruised, given what they thought they knew about the Fed's intentions.
"The market didn't arrive at the view that tapering would start in September entirely on its own. The Fed guided everyone there," wrote Mike Cloherty, head of U.S. rates strategy at RBC Capital Markets.
Fed Chairman Ben Bernanke didn't quite see it that way. In response to a reporter's question at his Wednesday press conference about the Fed confusing the markets, he said: "I don't recall stating we were going to do any particular thing at this meeting."
Bernanke emphasized there was no "preset course" or "fixed calendar schedule" for rolling back the Fed's purchases.
Not everyone, though, was surprised by the Fed's delay.
"The Street was heavily counting on a taper announcement, but we saw some wiggle room for the Fed after the August employment report came out weaker than expected," said Daniel Heckman, senior fixed income strategist at U.S. Bank Wealth Management in Kansas City, Missouri.
The decision "did show the market the Fed will be very careful about pulling the trigger," Heckman said. "There's no set date for them to taper. It's truly data dependent. Bernanke kept hammering away at that message." (Additional reporting by Dan Bases, Karen Brettell, and Julie Haviv in New York and Ann Saphir in San Francisco; Editing by Dan Burns and Tim Dobbyn)