US Treasury Market Pain Amplifies Liquidity Concerns

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NEW YORK — A sharp sell-off in U.S. Treasuries has raised concerns about low levels of liquidity in the $23.5 trillion market, which could amplify losses for investors already off to a start. bad year.

US government bond yields have soared this year as the Federal Reserve has become more aggressive about how aggressively it will raise interest rates to cool down the economy, hurting bond yields . The ICE BofA Treasury Index has posted its worst start to the year in history, down 6%.

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While liquidity in the US Treasury market has been an ongoing issue, traders and investors said there were particular concerns during this selloff.

“People who buy longer-dated Treasuries, like pensions, central banks and insurance companies, tend to stay away when there’s this kind of volatility,” said Ed Al-Hussainy, senior rates and currency analyst at Columbia Threadneedle. , adding that liquidity is “not good” and that trading large blocks of Treasuries “has become very difficult.”

The Treasury stock market is often one of the most liquid in the world, and the global financial system uses the instruments as a benchmark for asset classes. But it has seen liquidity problems, such as in late February and early March 2020, when fears of a pandemic caused market breakouts and liquidity rapidly deteriorated to 2008 crisis levels, leading to the Fed to buy $1.6 trillion in Treasury bonds to increase stability.

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Investors say liquidity concerns this year have not reached the point of threatening market performance, but concerns have been heightened by a number of factors.

One is that the Fed has stopped buying US Treasuries, after ending a bond-buying program this month aimed at supporting the economy during the coronavirus crisis.

“We are adjusting to this new world where the Fed is not a buyer,” Al-Hussainy said.

Some investors are also concerned that wild price swings in commodity markets due to the Ukraine crisis and sanctions on Russia, a giant commodity exporter, could create pockets of illiquidity in the financial system.

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“There are a lot of correlation risks that I think have reduced balance sheet availability for the system overall, so even Treasuries are affected by that,” said George Goncalves, head of US macro strategy at MUFG.

“There is a reduction in balance sheet capacity because people are reducing risk, and when you start to really dig into that, you start to think that there are side effects that reduce not only risk appetite but also the ability to trade,” said. he said she.

Some liquidity measures have shown stress.

Bid-ask spreads, a commonly used gauge of liquidity, widened significantly in March on short-dated Treasury notes, Refinitiv data showed.

Data from CME Group showed that the liquidity of the Treasury bond order book has decreased since February 24, when Russia began its invasion of Ukraine, and volatility has increased.

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Cash contract volume in terms of the book’s average daily maximum bid/ask amount for five-year Treasuries declined to $10 million in March from about $25 million in February.

For benchmark 10-year notes, order book liquidity fell to an average of $14 million in March from around $20 million in February.

However, relative volumes remained unchanged month-on-month.

Steven Schweitzer, senior fixed income portfolio manager at Swarthmore Group, said he had seen a “pretty big disconnect” at the short end of the US Treasury curve earlier this month, in a reminder of the lack of liquidity observed after the global financial crisis.

“Bonds and credit are the lubricant for the economy, and when the short end runs out, it’s a big red flag for us,” he said.

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The weakness in bonds this week came after Fed Chairman Jerome Powell said on Monday that the US central bank must act quickly to counter inflation that is too high and could use interest rate hikes. interest larger than usual if necessary.

Benchmark 10-year Treasury yields rose to 2.296% on Monday from 2.153% on Friday, and two-year notes soared to 2.117% from 1.942%, narrowing the gap between yields on those two maturities, a sign of that the market is anticipating a sharp economic slowdown.

With a Fed appearing increasingly determined to fight inflation despite the risk that tighter monetary policy could slow growth, there is less support for buying Treasuries, so the selloffs find little match to offset them, some investors said.

Expecting higher returns had become a consensus trade, investors said.

“People are probably on the right side of that trade right now,” said Matthew Nest, global head of active fixed income at State Street Global Advisors.

“The next sore trade is when and if yields go down again,” he added.

(Reporting by Davide Barbuscia, additional reporting by Ira Iosebashvili and Saqib Iqbal Ahmed; editing by Megan Davies and Jonathan Oatis)

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