The rush into Treasuries sparked by Russia’s war in Ukraine has exposed fresh signs of weakness in the world’s biggest bond market, adding to pressure on U.S. regulators to detail a reform plan.
The latest indications of poor trading conditions include a deterioration in the ability to buy or sell a security without moving its price, market participants say. There’s also a slump in the volume of trading of non-benchmark Treasuries, according to Bloomberg Intelligence.
The past several days’ trading, with two-year yields abruptly tumbling before ricocheting back, also suggests to some a degree of volatility that goes beyond normal reaction to new developments.
“This is the world’s safe haven—the risk-free asset that everyone holds in their portfolios—and you’d rather it not be so volatile,” said Praveen Korapaty, chief rates strategist at Goldman Sachs Group Inc. “There is broadly an issue of intermediation capacity in the Treasury market, and what Russia-Ukraine did was to provide an impetus for that fragility” to show, he said.
While the current strains are nothing like the abrupt squeeze in Treasuries trading seen in the crisis of March 2020, they illustrate continuing issues stemming from a mismatch between the gigantic size of the market and a limited ability among dealers to make a market. And regulators are under pressure to address them.
There’s now almost $23 trillion in marketable Treasuries outstanding, marking an 86% surge since September 2014—when a new regulation forced financial institutions to hold more capital against their portfolios, treating government debt the same as riskier assets that typically yield bigger returns over time.
That regulatory move—the adoption of the so-called the supplementary leverage ratio, or SLR—diminished dealers’ incentives to hold a stockpile of Treasuries for buying and selling to clients.
“The intermediation level from primary dealers hasn’t changed at all” since the time of the global financial crisis, even as the Treasuries market quintupled in size, said Jay Barry, head of U.S. government-bond strategy at JPMorgan Chase & Co. “Smaller demands on liquidity are causing bigger declines in these liquidity measures. That will be the story until we find a more long-term solution.”
Among the gauges of stress in the Treasuries market recent days:
• A measure of market depth—or the ability to trade without substantially moving prices—compiled by JPMorgan Chase & Co. has deteriorated to levels similar to around April 2020, just after the rupture in trading when the Covid crisis hit
• Counterparties to repurchase agreements are failing to follow through on their obligations at a level unseen in almost two years, a sign they’re having difficulty obtaining the Treasuries they need
• Dealer trading in off-the-run securities—those that aren’t the current benchmarks for the various maturities—has tumbled, according to Bloomberg Intelligence analysis
Federal Reserve Chair Jerome Powell said Wednesday that the U.S. central bank now provides “institutionalized liquidity provision,” which serves to support the functionality of financial markets.
The Fed last year created a standing repurchase facility to help ensure owners of U.S. government debt can at least obtain ready cash, and set up a similar permanent arrangement for foreign official holders of Treasuries. But that cannot make up for limited capacity in actually trading Treasuries.