Recent news and market analysis has featured a spate of warnings about diminished liquidity in the U.S. Treasury market and reminders of how quickly markets can seize. It’s a topic we’ve addressed on our blog with an investigation of the bond market sell-off of 2013.
As the Liberty Street Economics post notes, in markets such as the one for U.S. Treasuries, liquidity hinges in part on whether dealers respond to temporary imbalances in supply and demand by stepping in as buyers or sellers against trades sought by other market participants. The authors ask whether something has altered dealers’ willingness or ability to make markets. Their analysis weighs competing theories, including the role of regulatory constraints imposed in the wake of the financial crisis. They also develop some novel metrics for assessing dealers’ capacity for and interest in using their balance sheets to support market functioning.
In a related post, two of the same authors put the 2013 bond market turmoil in historical perspective. They find that the May-July episode ranked as the thirteenth largest sell-off since 1961, by their measure, and present evidence that the episode was driven by increases in the term premium, as opposed to changes in the expected path of future short-term interest rates.
Our bloggers plan to describe related analysis in a forthcoming series in Liberty Street Economics. Stay tuned.
Vault Reading:
Dealer Balance Sheet Capacity and Market Liquidity during the 2013 Selloff in Fixed-Income Markets
By Tobias Adrian, Michael Fleming, Jonathan Goldberg, Morgan Lewis, Fabio Natalucci, and Jason Wu
The Recent Bond Market Selloff in Historical Perspective
By Tobias Adrian and Michael Fleming
Disclaimer
The views expressed in this post are those of the author and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the author.
Anna Snider is a cross-media editor in the Federal Reserve Bank of New York’s Research and Statistics Group.
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There is nothing surprising about the fall in liquidity in the US treasury market. It is simply a reflection of the fact that money supply (my measure, called Corrected Money Supply) has been in relative contraction since the beginning of 2014. By relative I mean that although the absolute value of corrected money supply has been rising slowly, the YoY growth rate has been steadily falling. See the graph on http://www.philipji.com/item/2015-05-15/the-monetary-contraction-continues-at-a-slower-clip The danger of course is that the Fed will repeat the mistake that led to the Great Recession. Looking at the graph it seems that the Fed will begin raising interest rates precisely when the YoY growth rate of money is close to zero.