Davide Barbuscia, Ira Iosebashvili

NEW YORK (Reuters] – Investors who have already suffered a poor start to the year may be more worried about the liquidity of the U.S. Treasuries market.

The Federal Reserve has been more aggressive in raising interest rates, causing U.S. bond yields to spike this year. This is because it seems less hawkish and will increase them even further. It also made bond returns worse. The ICE (NYSE 🙂 BofA Treasury Index is at its lowest point in the past year, with a drop of 6%.

Graphic: Bonds bleed- https://graphics.reuters.com/USA-MARKETS/BONDS/klvykjgmovg/chart.png

Although liquidity has been a problem in the U.S. Treasury Market, investors and traders said that there were particular concerns about this sell-off.

“People who purchase longer-dated Treasuries such as pensions and central banks tend to stay away from when there is this kind of volatility,” stated Ed Al-Hussainy (senior rates and currency analyst at Columbia Threadneedle), adding that liquidity was “not good” and trading large blocks of Treasuries has become “very difficult.”

The world’s largest market for Treasury securities has a reputation for being one of most liquid. It also serves as an indicator for other asset classes. However, it has experienced liquidity issues such as late February 2020 and early March 2020. Pandemic fears led to market collapses. Liquidity rapidly declined to 2008 crisis levels. This prompted the Fed to purchase $1.6 trillion in Treasuries for stability.

However, liquidity concerns are increasing for a variety of reasons. Investors believe that they do not pose a threat to market functioning.

The Fed stopped buying U.S. Treasuries after it ended this month’s bond-buying program aimed at supporting and sustaining the economy in the aftermath of the coronavirus epidemic.

Al-Hussainy stated, “We’re adapting to that new world in which the Fed is no buyer.”

Some investors also worry that the Ukraine crisis and Russia sanctions, which are affecting the largest commodities exporter, will cause wild price swings on the commodities market. This could result in pockets of financial illiquidity.

George Goncalves from MUFG, Head of U.S. Macro Strategy, stated that “there are a lot more correlation risks than I think exist that have reduced balance sheet accessibility for the system as a whole, so even Treasuries get impacted.”

According to him, there is a decline in balance sheets capacity as people start de-risking. Once you get into the details, you realize that there can be knock-on consequences that not only reduce risk appetite, but also make it more difficult to trade.

Some liquidity measures have been shown to be stressed.

The spread of bids, a common indicator for liquidity, widened in March thanks to Treasury notes short-term. Refinitiv data revealed.

CME Group’s (NASDAQ:) data showed that order book liquidity for Treasuries declined from February 24, when Russia invaded Ukraine. Volatility has also increased.

The daily average book bid/ask volume for five-year Treasuries fell to $10M in March, from $25M in February.

The benchmark 10-year note order book liquidity fell from approximately $20 million to $12 million in Feb. to an average $14 million in March.

However, relative volumes remained the same month after month.

Steven Schweitzer of Swarthmore Group is senior fixed income manager. This was a reference to the liquidity shortage that has been evident in the wake of the financial crisis.

He stated that bonds and credit were the engine of the economy and that if the long end is drying up it was a warning sign.

This week’s weakness in bonds was caused by Jerome Powell, Fed Chair, stating Monday that the U.S. central banks must act quickly to combat high inflation and could increase interest rates if necessary.

The benchmark 10-year Treasury yields rose to 2.969% Monday, from 2.153% Friday. Two-year notes soared to 2.117%, from 1.942%. This is a signal that the market anticipates an economic slowdown.

A Fed that sounds more determined to combat inflation, despite risks of tighter monetary policies slowing growth may mean there’s less support to buy Treasuries. Therefore, investors stated, sell-offs have little to counter them.

Investors agreed that higher yields were a common expectation.

Matthew Nest, the global head for active fixed income said, “People probably are on the right side now.” State Street (NYSE:) Global Advisors.

He added, “The next pain trade will be when yields return down.”