Futures Expiration Puts Global Bond-Market Liquidity to the Test

(Bloomberg) -- The erosion of liquidity in the U.S. Treasury market is causing headaches in the futures market, where the quarterly process of swapping expiring contracts for new ones is under way and set to ramp up over the next week.

What is normally a pedestrian event, the “calendar roll” -- in this case the switch out of December-expiring futures for Treasury notes and bonds into March-expiring ones -- has potential to cause casualties because of volatility in the underlying securities. Price swings in Treasuries, particularly short-maturity issues, have been violent in recent weeks as surging consumer prices put pressure on Federal Reserve policy makers to raise interest rates.

Wall Street is advising customers to take heed. Barclays Plc strategists Andres Mok and Amrut Nashikkar said roll activity is likely to be more volatile than normal amid “worsening” liquidity. JPMorgan Chase & Co.’s Srini Ramaswamy and Veronica Mejia Bustamante said the roll needs to account for “deterioration of market liquidity.” 

The two-year futures roll is seen as particularly vulnerable. Order-book depth for the contract “collapsed and has remained abnormally low,” Bank of America Corp. strategist Mark Cabana said in a Nov. 15 report. In the cash market, JPMorgan strategists began observing “significantly depressed” depth nearly a month ago.

In the U.S. rates market, the Bank of America MOVE index closed at highest level since April 2020 on Friday, and the bid in rates volatility was extended in Monday’s session. 

The U.K. government-bond futures market sent up a flare last week. A burst of roll activity on Thursday amounted to 88,000 contracts, more than 10 times Wednesday’s total, and prices swung wildly. Open interest in the December 2021 and March 2022 contracts, reported the next day, slumped, suggesting positions were closed out. The gilt market had been rocky since the Bank of England’s Nov. 4 shock decision not to raise rates.

Whether a similar fate awaits Treasury futures remains to be seen, but it won’t come as a surprise.

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