Trading conditions in $ 22 billion treasury market deteriorate ahead of Jackson Hole

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Trading conditions in the $ 22 billion U.S. government bond market, a staple of the global financial system, have deteriorated as traders prepare for a key speech this week by Federal Reserve Chief Jay Powell.

Liquidity, or the ease with which traders can buy and sell bonds, worsened as a series of jerky price movements and uncertainty about the Fed’s policy kept investors from making big bets. Low trading volumes, with many market participants absent in August, compounded the problem.

The Treasury Market is the largest, deepest, and most important bond market in the world and serves as a benchmark used to value trillions of dollars in assets around the world.

Policymakers and investors have been scrutinizing trading conditions following market turmoil in March 2020, during which sudden drops in liquidity contributed to the acute volatility of Treasuries. A massive sell-off earlier this year highlighted the persistence of difficulties even as markets broadly stabilized.

The recent drop in liquidity comes as Powell prepares to deliver a speech at the Jackson Hole summit this week, typically one of the biggest events on the economic calendar of the year. Reduced liquidity is important because it can lead to large price fluctuations.

“Liquidity is lousy,” said Andrew Brenner, head of international fixed income at NatAlliance Securities. And that could “absolutely cause potential problems next week if Powell has something big to say.”

Bid-ask spreads for the 10-year benchmark bond and 30-year bond in early August hit 5.5-month highs. Spreads are now slightly below those levels, but remain high and widened again last week. Since the Treasury market is so actively traded, this spread, which tracks the difference between the price buyers are willing to pay and the price sellers are offering, is usually narrow.

Guneet Dhingra, head of US interest rate strategy at Morgan Stanley, said bid-ask spreads widened for two reasons: “The first is that this is the month of August and that volumes are generally lower in August. . . and I also think the rate markets have become somewhat confusing for investors and people have a higher degree of risk aversion. “

Last week, Goldman Sachs’ liquidity index for 5-year and 10-year Treasuries fell well below their 21-day average. Another measure of liquidity – JPMorgan’s market depth gauge – also recently fell to its lowest since March. At the same time, analysts at JPMorgan said last week that individual transactions also had a greater effect on prices; the ability to buy or sell securities without causing large price changes is another indicator of liquidity.

Minutes from the latest Fed policy meeting revealed disagreement among members over when the central bank could start withdrawing its $ 120 billion in monthly asset purchases, the first step in unwinding its support to the economy in times of crisis. Investors will follow Powell’s Jackson Hole speech on Friday for any sign of a decision on when or the pace of that decline.

It was not just August’s trading volumes and the uncertainty over the Fed’s path that dried up liquidity. A fall in Treasury yields since mid-May has baffled many investors as it came even as many economists and the Fed itself have optimistic prospects for economic growth and the job market.

“A lot of clients haven’t particularly understood how the rate markets have moved and this has brought a degree of caution that you wouldn’t normally see,” Dhingra said.