Signs of stress in the Treasury market
A who’s who of financial regulatory agencies are convening Wednesday to talk about how to ensure the $22 trillion Treasury market functions properly.
At issue: Fixing liquidity problems that have, at times, exacerbated price swings.
Why it matters: U.S. Treasuries are the benchmark for all other financial markets. Large price moves here mean a revaluing of all the assets pegged to them — everything from U.S. corporate bonds to equities to mortgages.
State of play: Signs of illiquidity have cropped up this year, even as the Federal Reserve has been plowing extra funds into the market with its monthly bond purchases.
- “We're near peak liquidity as far as global central banks go, and we're seeing some signs that all is not well … It’s unsettling,” Mark Cabana, rates strategist at BofA, tells Axios.
What's happening: For one, there was the startlingly weak auction for 30-year Treasuries last week on the back of worse-than-expected inflation data.
- Markets in the 20-year Treasury note have also experienced low liquidity. So have those in certain Treasury futures, as well as Treasury inflation-protected securities breakevens (an indicator of inflation expectations), BofA analysts wrote in a report on Monday.
Context: The plight stems from a pullback on the part of macro hedge funds that faced steep losses on their positions earlier in the fall — and have stepped out of the market, Cabana says.
- But events of the recent past — from a sloppy auction back in February to the market’s near-collapse in March 2020 — also underly the current dialogue.
The backstory: Primary dealers — mainly banks who facilitate liquidity by making markets in the paper — have scaled back their activity due to capital constraints imposed by post-financial crisis regulations.
- But over the same period, the Treasury market has ballooned to nearly $22 trillion, from $5 trillion.
The seventh annual U.S. Treasury Market Conference on Wednesday — featuring speakers like SEC chair Gary Gensler and New York Fed President John Williams — isn't going to solve liquidity for the bond market.
- But it is going to bring high-level representatives from the government sector together with market participants from the private sector who buy and sell the bonds that fund our government.
- Regulators don't want to be reactive to one-off events or short-term blips — they do want to pave the way for a better functioning market that isn't prone to large and disorderly moves.
What’s next: Wednesday's discussions — and the potential studies and papers that come out of them — could help inform policymaking.
- Treasury has already proposed reforms like expanded central clearing of trades, gathering better data on positions and transactions, and investigating the role that levered hedge funds play in the market.