Treasury Market Liquidity Sours as Traders Gird for Taper Clues

The ability to trade in the world’s biggest debt market is deteriorating just as traders are on high alert ahead of the Federal Reserve’s Jackson Hole symposium next week for clues on the timeline for tapering stimulus.

A key gauge of Treasury liquidity -- market depth, or the ability to trade without substantially moving prices -- has fallen to the lowest in more than five months, according to JPMorgan Chase & Co. data. Ten-year yields hover at about 1.25%, up from a six-month low of 1.13% touched on Aug. 4. Stronger-than-expected July payrolls released earlier this month gave some lift to yields though growth concerns triggered by surging coronavirus cases has since weighed on them.

Treasury Market Liquidity Sours as Traders Gird for Taper Clues

“Treasury market depth has continued to decline in recent weeks, and now at its lowest levels since early March, when yields were moving rapidly higher amid increased vol and a series of weak Treasury auctions,” JPMorgan strategist Jay Barry wrote in a note with his colleagues. “Moreover, price impact has risen as well, indicating the footprint of each trade in the Treasury market is approaching the upper end of the range observed over the past year.”

More Common

Some of what’s going on is typical in the U.S. in August, when many bond traders take vacation. Yet they have been saying for years that bouts of liquidity shortfalls, sometimes severe, have become more common.

The release Wednesday of the minutes from the Fed’s July meeting is also keenly in focus for clues on the central bank’s tapering plans.

JPMorgan’s market-depth measure is based on data the bank obtains for the average size of the best three bids and offers for trades between 8:30 a.m. and 10:30 a.m. in New York each day. That particular metric plunged in March 2020 to levels not seen since the 2008 financial crisis. For the price impact, its derived from the average move in order book mid-prices against a $100 million in notional value traded.

The Fed responded to the dire level of liquidity in March 2020 with purchases of Treasuries and mortgage securities that together peaked at more than $100 billion a day. The tempered liquidity level now is nowhere near as bad as last year, though monitoring it remains important to investors as they try to attain meaning from swings in yields, which also are linked to pricing of many other fixed-income securities. 

Federal Reserve Bank of Minneapolis President Neel Kashkari said in an interview on Bloomberg’s “Odd Lots” podcast recorded Aug. 9 that a few more strong jobs reports in the coming months would mark enough progress in the recovery from the pandemic to let the Fed begin winding down its bond-buying program.

The Fed is currently buying $120 billion in securities a month, made up of $80 billion Treasuries and $40 billion of mortgage debt. 

©2021 Bloomberg L.P.

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