Bond yields have seen wild swings as the lack of liquidity has widened price differentials between investors buying and selling Treasuries. This means that trades that previously did not move the market now create more volatility. Rate-sensitive growth stocks are particularly vulnerable, as borrowing costs are already rising with Fed rate hikes.
In fact, Treasury liquidity is showing signs of weakness not seen since the Great Financial Crisis, warned James Demmert, founder and managing director of Main Street Research.
“You only have to look back to 2008 or the pandemic to understand the severity of a liquidity freeze – especially in the US Treasury market – which is considered the most liquid market in the world,” he said. . “A liquidity crunch would most likely extend the current bear market in equities to much deeper levels, in the range of another 20-25% or a total of 50% for the year.”
The cash crunch comes as the biggest buyers of US Treasuries pull back. For example, Japan has always been a top buyer of US debt, but recently sold dollar-denominated assets to support the yen’s fall as the dollar soars. Meanwhile, the Federal Reserve has stopped buying bonds and is now shrinking its balance sheet.
And large institutions are less inclined to serve as Treasury market makers because the so-called extra leverage ratio forces them to invest more capital and increase their reserves.
Analysts expect the government to take action. OANDA senior market analyst Ed Moya said the Treasury Department will have to repurchase older securities and replace them with larger current ones, while the Federal Reserve may modify its permanent repo facility. .
Treasury Secretary Janet Yellen recently acknowledged the possibility of buybacks after her department surveyed Treasury bond dealers about a potential program.
The stakes are high, not just for the stock market, but for all financial markets. Demmert said high-yield bonds would also be likely to take a hit, while lower-quality fixed-income securities would bear the brunt of the pain.
And according to a note by Ralph Axel of Bank of America, “decline in liquidity and resilience in the Treasury market is arguably one of the greatest threats to global financial stability today, potentially worse than the bubble. real estate from 2004-2007”.
He added that the ripple effects could also extend to emerging markets as well as consumer and business confidence. And if U.S. Treasury transactions ever stopped, business, household, and government borrowing in securities and loans would likely stop.
“While it sounds like a bad sci-fi movie, it’s unfortunately a real threat that has absorbed a lot of man-hours over the past 10 years with very little output from regulators or legislators,” indicates the rating.