Treasury-market liquidity is back in focus — but don’t panic yet
Treasury-market liquidity is back in focus — but don’t panic yet
Questions are being raised again inside the $27 trillion Treasury market, home of one of the world’s safest and most liquid assets, about the ease with which some U.S. government securities can be bought and sold without a big impact on price.
Signs of stress were seen on Wednesday in dealer positions on maturities of less than six years, as reflected by a “red” reading on J.P. Morgan’s Liquidity Stress Dashboard. Positions on 6- through 11-year maturities, as well as those of more than 11-year maturities, were also flashing warnings.
Nonetheless, much of the Treasury market still looks normal — triggering disagreement over whether there’s a bigger problem looming ahead. Trading was calm on Thursday after the government’s revised first-quarter GDP report pointed to still-soft economic growth, with 2- 10- and 30-year yields closing slightly lower on the day.
While some market participants said there’s no sign of larger liquidity troubles on the horizon, Robin Brooks, a senior fellow at the Washington-based Brookings Institution and former chief FX strategist at Goldman Sachs, used strong words on social media this week to describe what he’s seeing. He wrote that “something bad is happening in the U.S. Treasury market,” citing a Bloomberg liquidity index tracking government bonds.
Meanwhile, Torsten Slok, chief economist at Apollo Global Management in New York, wrote this week that liquidity is deteriorating in the Treasury market and sending “worrying signals.’’ He reached this conclusion by looking at what’s known as average yield errors across the universe of government notes and bonds with remaining maturities of one year or more. When liquidity conditions are favorable, the average yield errors are small. But this isn’t currently the case, according to a chart he provided.
The market for U.S. government debt has been hit with repeated bouts of liquidity concerns over the past few years. As recently as last March, worries about the global banking sector impacted the ease of buying and selling Treasurys and their German counterparts at quoted prices. The Treasury market was also plagued with illiquidity in March 2022 as the Federal Reserve’s interest-rate-hiking cycle got underway.
And in 2020, the Covid-19 pandemic sparked a global flight to cash that disproportionately impacted the Treasury market, leading to selling pressure that was “more pronounced and broad-based” than in other government-bond markets, according to studies done by the New York Fed.
Earlier this year, Sean Campbell, chief economist and head of policy research at the Financial Services Forum in Washington, wrote an online blog titled “The Evidence Is Conclusive: Treasury Market Liquidity Has Deteriorated Significantly.” He said that there’s been a “quite consistent and dramatic” decline in market depth, or the amount of an asset that can be bought or sold at the prevailing price, and that this, in turn, signals a “significant decline” in liquidity.
The Treasury Department has attempted to address concerns about the bond market’s resiliency by reintroducing its first buyback program in more than 20 years. Those buybacks began in May.
Thomas Simons, a U.S. economist for Jefferies, said he’s skeptical the buyback program will have a huge impact on liquidity. Perhaps more importantly, though, he isn’t sensing any bigger issues with liquidity at the moment.
“Certain areas, such as off-the-run, are a concern,” he said via phone on Thursday, referring to older, less actively traded bonds. “But I don’t really have any evidence that things have changed much other than seasonality issues, with it being summer and people being less involved.”
There are still a number of “structural issues, with a trend in dealers moving away from being a conduit of the auction process,” Simons said — which reduces the amount of perceived backup in liquidity that might be available if things go wrong.
Joseph Adinolfi contributed.