SDR - New World Money

[gfp927z]

>>> Rocky Treasury-Market Trading Rattles Wall Street

Mounting illiquidity raises concerns over a key market’s functioning should a crisis erupt


The Wall Street Journal

By Matt Grossman and Sam Goldfarb

Oct. 30, 2022


https://www.wsj.com/articles/rocky-treasury-market-trading-rattles-wall-street-11667086782


Rising friction in the trading of U.S. government debt has investors worried about the health of a $24 trillion market that is critical to the functioning of the broader financial system.

The ranks of traders ready to buy and sell Treasurys are shrinking. Individual trades are moving prices more. Treasury securities with similar characteristics are trading at larger-than-normal price differences. Major players, including the big banks and asset managers that have long been significant buyers, are in retreat.

Investors expect to be able to buy and sell Treasurys quickly at the listed price, no matter what else is happening. Difficulty doing so reflects a lack of what traders call liquidity, and it can scramble the most basic signals that help the economy run: How much home buyers should expect to pay for a loan, what kinds of investments businesses should make, and what kinds of stocks likely will perform the best in a given period.

Climbing Treasury yields have recently sent mortgage rates above 7% for the first time in two decades, slashed stock valuations and slowed corporate borrowing. While there hasn’t been a serious breakdown in Treasury trading so far, the possibility is far from unthinkable given the tumult this year. Many traders and portfolio managers warn that such a development would tear through other markets, potentially requiring intervention from the Federal Reserve to prevent a full-blown financial crisis.

Andrew Kreicher, a director at Wells Fargo, said liquidity in Treasurys has been about the worst he has seen over a sustained period recently.

“There are so many systems in other asset classes that use Treasurys as a building block,” he said. “If you have rot in the foundation, the whole house is at risk.”

Investors rely on easy Treasury sales to obtain quick cash for debt payments, margin calls and a variety of other pressing short-term needs. When that process hits hiccups, financial trouble can spiral, said Jim Caron, a fixed-income portfolio manager at Morgan Stanley Investment Management.

“If the Treasury market isn’t working, nothing is working,” he said.

While many agree trading Treasurys remains smoother than during the worst moments of 2020’s pandemic-fueled market breakdown, the current unease has built gradually over months without a single precipitating event, said Deirdre Dunn, co-head of global rates at Citi.

Some traders believe the Fed’s rapid interest-rate increases are the main cause. Treasurys—especially shorter-term notes—closely reflect expectations for the Fed’s overnight rates, so quick changes can cause choppy moves. This week, the Fed is expected to raise rates by 0.75 percentage point for the fourth straight meeting.

Other traders lay some blame on rules enacted after the global financial crisis that make it more expensive for banks to keep Treasurys on their balance sheet.

Big banks function as Treasury-market dealers, helping match buyers and sellers. When they step back, trading stalls, said Ariel da Silva, director of fixed income at Wealth Enhancement Group, a wealth-management firm. Given the current regulatory regime, “It doesn’t behoove them to take on the inventory,” he said.

Measuring the ease of trading isn’t straightforward. Some approaches gauge the differences between the prices buyers and sellers are demanding. Others look at how much deal flow the market can absorb at the current price, or, similarly, how much a single large trade swings prices for everyone else.

“We’re seeing plenty of concerns about liquidity, but it’s coming at the same time that we’re seeing real concerns about volatility, and it’s very difficult to untangle those things,” said Steven Abrahams, a senior managing director at Amherst Pierpont Securities. During the Fed’s smaller, more predictable rate increases between 2004 and 2006, trading stayed more fluid, he said.

One problem is a growing difference between yields on the newest Treasurys in the market and older vintages that are still traded among investors. Theoretically, a five-year note sold this year should trade at the same yield as a five-year-old 10-year note, because both come due in 2027. But fresh Treasurys are trading at a growing premium to older notes, a sign the older securities have become harder to find buyers for.

To address that issue, Treasury Department officials have considered buying back outstanding bonds, funding the purchases with auctions of more fresh debt. Earlier in October, the Treasury surveyed dealers for feedback on the plan, a version of which the government enacted to sustain the market during the budget surpluses of the early 2000s. Treasury Secretary Janet Yellen said the department is still studying it.

For now, doing business in Treasury markets takes more finesse than a year ago, traders say. Some report working harder than usual to shield their intentions from the broader market, lest their bids or offers send jumpy prices moving against them.

Trading conditions aren’t nearly as difficult as they were in March 2020, when dealers demanded extraordinarily large discounts to buy Treasurys from investors, said Michael Lorizio, a senior fixed-income trader at Manulife Investment Management. But he has sometimes found it necessary to make larger trades “in a more quiet way” than in the past, communicating his intentions to dealers carefully rather than “just blast it out there without any sort of qualifications.”

Upheaval in U.K. bond trading this autumn showed one scenario investors hope the U.S. can avoid. In September, a new debt-heavy British budget plan ignited such a sharp bond-price decline that U.K. pension plans had to sell bonds to cover esoteric bets on a strategy called liability-driven investment. Yields soared, forcing the Bank of England to step in as a buyer even though it had been reducing its bondholdings before the furor began.

In the U.S., the Fed’s own effort to trim its holdings of Treasurys—part of the central bank’s anti-inflation efforts—is yet another factor some traders blame for falling liquidity. The program, known as quantitative tightening, amounts to “a mechanical withdrawal of liquidity” that reduces banks’ ability to absorb government debt, said Alex Lennard, investment director at Ruffer, a British investment fund.

Still, the Treasury market continues to process massive trading volumes without disruption. Last month, an average $570.5 billion of Treasurys changed hands daily, similar to levels in recent Septembers, according to data from Sifma, a financial-industry trade group. Daily U.S. stock trading last month, by comparison, was $510.5 billion.

Trading Treasurys remains far more frictionless than trading corporate bonds or other debt securities.

“Internally, when I complain about liquidity, our corporates guys are quick to tell me to stop whining,” said Mr. Lorizio.

<<<



---