US Treasury Market Liquidity Returns to Pre-Fed Tightening Levels, Reports NY Fed

By Davide Barbuscia

NEW YORK – According to a report from the New York Federal Reserve, liquidity in the $27 trillion U.S. Treasury market has returned to levels seen prior to the Federal Reserve’s interest rate hikes that began in 2022.

The liquidity of an asset indicates how easily it can be traded without causing significant price changes. It has deteriorated over the past few years due to sharp fluctuations in U.S. government bond prices amid rate increases aimed at controlling inflation.

Michael Fleming, head of Capital Markets Studies at the New York Fed, noted that indicators of trading conditions suggest liquidity in the Treasury market is set to improve in 2024, reaching levels comparable to those before the current monetary policy tightening began.

Fleming highlighted enhancements in the bid-ask spread—the difference between the highest price buyers are willing to pay and the lowest price sellers will accept—reporting that spreads have been narrow and stable since mid-2023, following a period of widening after the regional banking crisis in March of the previous year.

Additionally, the depth of the order book—the average number of securities available for purchase or sale at the best prices—has increased since March, although it experienced a decline in early August due to a disappointing jobs report and an unexpected rate hike by the Bank of Japan.

There has also been a positive shift in the price impact of trades, which measures how much the price of an asset changes when a trade occurs. After a significant rise during the banking turmoil in March 2023, the price impact has been decreasing, reaching levels last seen in late 2021 and early 2022, before rising again in early August 2024.

In recent years, regulators and the Treasury have implemented various reforms to enhance trading conditions and prevent disruptions in this critical bond market. Despite these efforts, concerns linger among market participants about vulnerabilities that might resurface, as observed during the liquidity crisis in March 2020, especially amidst increasing government debt supply.

Fleming reported that the recent improvements in liquidity have coincided with a decrease in price volatility. However, a measure of Treasury liquidity based on yield deviations has shown continued deterioration.

"The market’s ability to manage large trading volumes smoothly remains a significant concern," he stated. "As outstanding debt continues to grow, recent research indicates that limitations on intermediation capacity can exacerbate illiquidity."

Fleming concluded that ongoing monitoring of Treasury market liquidity and sustained efforts to enhance market resilience are essential.