US Treasury market liquidity has returned to pre-Fed tightening levels, NY Fed says

By Davide Barbuscia

NEW YORK (Reuters) – Liquidity in the $27 trillion U.S. Treasury market, the world’s largest market for government bonds, has returned to levels seen before the Federal Reserve begins raising interest rates in 2022, according to a report from the New York Fed.

Liquidity – or the ability to trade an asset without significantly changing its price – has worsened in recent years as US government bond prices have swung sharply since the US central bank began raising rates to tame inflation.

But common measures of trading conditions “point to an improvement in Treasury market liquidity in 2024 to levels last seen before the start of the current tightening cycle,” said Michael Fleming, head of Capital Markets Studies at the Federal Reserve Bank of New york. Research and Statistics Group, said Monday in a post on the New York Fed’s Liberty Street Economics blog.

Fleming saw improvements in the bid-ask spread, which is the difference between the highest bid price and the lowest ask price for a security. Spreads have been narrow and stable since mid-2023, after widening following regional US banking turmoil last March, he said.

The depth of the order book, or the average amount of securities available for sale or purchase at the best bid and offer prices, has also increased since March last year, he said, although it decreased in early August this year , when a job weaker than expected. market report and a surprise rate hike by the Bank of Japan rattled financial markets.

Finally, Fleming saw an improvement in trade price impact, which measures the change in price that occurs when a buyer or seller initiates a trade. After rising sharply during the banking crisis in March 2023, the price impact has fallen to levels last seen in late 2021 and early 2022, he said, before rising again in early August 2024.

Regulators and the Treasury itself have launched a series of reforms in recent years to improve trading conditions and avoid disruptions in the world’s largest bond market. However, many market participants remain concerned that vulnerabilities from previous incidents, such as in March 2020, when liquidity deteriorated rapidly amid pandemic fears, could re-emerge in the face of spikes in volatility and as the supply of government debt continues to rise.

Recent improvements in liquidity have been accompanied by a decrease in volatility, or price swings, Fleming said.

However, an indicator for Treasury liquidity that measures deviations between certain Treasury yields continued to deteriorate, he added.

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“The market’s ability to smoothly handle large trade flows has been an ongoing concern since March 2020… outstanding debt continues to rise and recent empirical studies show how constraints on intermediation capacity can exacerbate liquidity crunches,” he said.

“Careful monitoring of treasury market liquidity and continued efforts to improve market resilience remain appropriate.”

(Reporting by Davide Barbuscia, editing by William Maclean)