Treasury-market liquidity has mostly righted itself since the dislocations caused by the several regional bank failures in March, according to a Federal Reserve Bank of New York economist.
Liquidity in the US government bond market “continues to closely track the level that would be expected by the path of interest rate volatility,” Michael Fleming, head of capital market studies at the New York Fed wrote in a post on its Liberty Street Economics blog Tuesday. It “worsened abruptly” after the failures of Silicon Valley Bank and Signature Bank in March, but recovered quickly.
Fleming’s assessment of “whether liquidity has been unusual given the level of volatility” found that five- and 10-year Treasuries conform, while two-year notes show “somewhat higher-than-expected price impact given the volatility.”
Liquidity, the cost of converting an asset into cash and vice versa, can be measured in various ways. Fleming’s analysis uses spreads between bid and offer prices, order-book depth, and the price impact of trades for the the most recently auctioned two-, five- and 10-year notes during the New York trading day.
The difference between the lowest offered price and highest asked price, known as the bid-ask spread, widened for all maturities in March, however for the 2-year note the extremes exceeded those at the height of the pandemic-induced crisis of March 2020, Fleming found.
The average quantity of securities available to buy or sell at the best level in the order book also declined during the regional banking crisis. The price-impact measure showed similar deterioration. All metrics improved within a month or so, Fleming found.
The regional bank failures sparked steep declines for Treasury yields, with the two years falling the most since 1982. Until that point, yields have been in a rising trend since the Fed began a series of interest-rate increases in March 2022 aimed at curbing inflation.
Following several breakdowns in Treasury market liquidity since 2014, regulators are in the midst of a multipronged effort to shore it up.
“While Treasury market liquidity has not been unusually poor given the level of interest rate volatility, continued vigilance by policymakers and market participants is appropriate,” Fleming wrote.
“The market’s capacity to smoothly handle large trading flows has been of concern since March 2020,” and recent research “shows how constraints on intermediation capacity can exacerbate illiquidity.”
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