The Federal Reserve on Friday confirmed what many investors have been saying for some time: The $24 trillion Treasury market has seen low levels of market liquidity in recent months.
The central bank has been raising interest rates rapidly since March as part of a fight to bring inflation down from a 40-year high. The hope has been that such measures could cool consumer demand enough to bring prices under control, without plunging the economy into a painful recession or triggering a financial crisis.
But since May, liquidity cracks in Treasuries, the largest and deepest part of the US bond market, have started to appear as both the 2-Year Treasury TMUBMUSD02Y,
and the 10-year Treasury TMUBMUSD10Y,
rates have climbed above 4%, highs last seen around 2008.
“Liquidity measures, such as market depth, suggest Treasury market liquidity remained below historical norms,” the Fed said in its latest financial stability report on Friday. “Low liquidity amplifies asset price volatility and can ultimately harm market functioning.”
Liquidity issues “could also increase funding risks for financial intermediaries that rely on marketable securities as collateral,” the report says, while highlighting potential ripple effects that could greatly amplify risks to stability. financial.
Importantly, the report also states that market participants so far “have continued to meet their margin calls to date.”
Here is a chart from the report ranking liquidity risks against other potential destabilizing factors that could weigh on the financial system, including persistently high inflation, Russia’s war in Ukraine, rising energy prices and the China-Taiwan conflict.
The U.S. Treasury Department said in October it was talking to senior traders and considering buying back some of its older debt to help avoid malfunctions in the Treasury market.
See: ‘It’s not QE or QT. It’s none of that. Why the US Treasury is considering debt buybacks
The Fed on Wednesday raised its rate by 0.75 percentage points, to a range of 3.75% to 4%. This is the highest level in 15 years,