Davide Barbuscia
NEW YORK (Reuters) – USD Investor The trillion-dollar U.S. Treasury market is trimming orders and shifting to easier-to-trade bonds to accommodate cyclical illiquidity that gets worse as the Fed shrinks its bond portfolio.
The Fed initiated “quantitative tightening” (QT) in June, letting its bonds mature without buying more. The exit of the biggest buyer of the U.S. Treasury market and uncertainty over future interest rate hikes to combat soaring inflation have led to wild price swings. Many investors have changed their trading patterns, while others have stayed on the sidelines, according to more than half a dozen traders and investors interviewed by Reuters.
million or more, you may have to start with a smaller Do it in bite size,” said Calvin Norris of Portfolio Aegon (NYSE: AEG) Asset Management manager and U.S. rates strategist.
-run is more liquid than the old “off-the-run” Treasury bonds. More niche products like Treasury inflation-protected securities are also less liquid.
The Treasury market is the largest in the world The bond market is the global benchmark for a range of other asset classes, making it the largest bond market in the world. Price volatility is particularly worrying.
By looking at untapped arbitrage opportunities in the U.S. Treasury market To measure liquidity by its size and persistence, investment bank Piper Sandler last month estimated the market to be “by far the most illiquid market” in the past years, except, of course, the Great Financial Crisis.” The graph below is reproduced from Piper Sandler’s research.
Chart: US Treasury Liquidity – https://fingfx.thomsonreuters.com/gfx/mkt/akpezkdkyvr/Pasted%20image%630.png
Transaction volumes have remained stable this year, with an average monthly total of approximately 630 $1 billion. But investors say liquidity — the ability to trade assets without significantly changing their prices — has deteriorated.
According to Andrew Brenner, head of international fixed income at National Alliance Securities, for example, $100 million, needs to be broken down to $80 or $ million dollars to be able to trade without moving the price.
“You have to break it or the market is against you,” he said.
When trying to trade illiquid products, some investors said they were struggling to find offers from willing traders.
Michael Kushma, Morgan Stanley Chief Investment Officer, Global Fixed Income) (NYSE: MS) The investment manager said at some point this year his firm had to swap out the bonds they were trying to sell because The bid discount offered by the dealer is too high.
So far, the Fed has allowed 80 $1 billion in US Treasuries to make Expiring and rolling off its nearly $9 trillion balance sheet, the company plans to shrink its balance sheet nearly twice as fast as it went from 2017 to 2017.
When the pandemic hit, the Fed was buying up to 25 $1 billion per month of U.S. Treasuries to boost the economy, but now it will increase Treasury tax cuts to 60 $1 billion a month.
‘LESS CAPITAL’
Market volatility and recession fears make market makers less willing to take large positions.
“When liquidity dries up dealers don’t know where the price is…so they’re reluctant to buy and make a market in it because they don’t know where they’re going to sell,” Kushma said.
Some investors noted that traders have struggled for years to keep up with the ballooning Treasury market and said regulators could do more to free up liquidity after promising to address structural issues in the market .
They said that if the Fed removes a rule introduced after the 2008 financial crisis requiring them to hold capital on U.S. Treasuries, Traders can buy more bonds. The Fed temporarily suspended the rule in 2020.
“There is less market maker capital ready to step in and push yields back to fair value,” said Steven Abrahams, senior managing director at Amherst Pierpont Securities.
Some people use 20 years of US Treasuries as an example to illustrate how illiquid damage the transaction. Since its reintroduction in 2020 there has been little demand for the tenor. This makes it more difficult to execute carry trades, such as combining risk exposure with -th one year.
Investors said liquidity had fallen more sharply in recent weeks amid thin summer trading and renewed uncertainty about the Fed’s positivity in raising interest rates.
“The lack of certainty about the Fed’s direction…just puts liquidity and typical liquidity providers in hold mode,” said John Luke, fixed income analyst at Aptus Capital Advisors Tyner (John Luke Tyner) said.
ICE (NYSE: ICE) BofA MOVE Index – a measure of expected volatility in U.S. Treasuries – hit 156 early July, slightly lower than March 156 156 peak 2020 , when pandemic fear hangs over investors and liquidity drops rapidly to 156 crisis level. This prompted the Fed to buy $1.6 trillion in US Treasuries.
Some investors said heightened fears of a recession could persuade the Federal Reserve to slow or stop quantitative tightening. If it continues to tighten, many don’t think the liquidity problem will end immediately.
“It feels like this is going to be the new normal,” said John Madziyire, senior portfolio manager at Vanguard.
