The previous decade has been a little bit of a seminar on totally different market situations for US Treasuries.
We’ve had 1) good market liquidity and performance within the zero-rates period, 2) good liquidity and dysfunction throughout the flash rally, and three) illiquidity and dysfunction across the Covid-19 shutdowns and reopenings.
It now appears to be like like 2022 has introduced a brand new mixture: Illiquidity paired with first rate market operate.
JPMorgan’s charges strategists level out in a word this week that market depth has declined considerably up to now yr:
. . . market depth has declined about 60% during the last yr and is sitting at ranges solely seen in late-2008/early-2009 on the tail finish of the GFC and in spring 2020, popping out of the worldwide COVID-19 lockdown. Elevated Treasury curve dispersion additionally alludes to weakened liquidity situations.
That echoes a submit from the New York Fed’s Liberty Avenue Economics weblog, which discovered an identical decline in market depth, and a “modest” widening in bid-ask spreads:
And an increase within the value affect of trades:
So it’s been dearer to commerce, and more durable to maneuver paper in dimension.
Notably, nonetheless, there haven’t been extreme dislocations like these seen across the unusually rough 7-year auction in 2021, or the early days of Covid in 2020.
Each JPMorgan and and the New York Fed level out that the primary driver of the illiquidity is nice old school value volatility. That’s the sort that comes from basic financial elements and Fed coverage, not international buyers panicking over a pandemic and fleeing to greenback markets. In different phrases: Period threat has returned to Treasuries.
Again to JPMorgan:
After we take a step again, it’s clear financial coverage uncertainty and the related improve in volatility propelled the declines we’ve seen in varied measures of liquidity this yr, however there has additionally been an overlay of market construction adjustments which go away these measures at decrease ranges than we might in any other case anticipate. Nevertheless, in contrast to prior episodes of equally low liquidity, we don’t assume we’re within the midst of a disaster, as a result of the Treasury market continues to operate in comparatively regular style. As we are able to inform, there isn’t a discernible liquidity desire in on-the-runs versus off-the-runs . . . On-the-runs commerce with a premium relative to their close to off-the-run cousins, however these ranges usually are not out of line with common ranges noticed over the previous 15 years, and don’t present any indicators of misery, in distinction to early-2020 and late-2008.
And a few measures of market liquidity don’t look almost as dire:
Sellers are warehousing extra Treasuries, too! “Inventories have risen considerably in 2022,” the financial institution writes.
Over the long term, sellers’ holdings haven’t grown almost as a lot because the market — that’s the place the hedge funds have stepped in. However we at Alphaville are sufficiently old to recollect when rules and excessive ranges of Treasury issuance had been supposedly going to trigger major sellers to stop making markets altogether.