US Treasury market liquidity back to pre-Fed policy tightening levels – NY Fed

The US Treasury market liquidity is now back to levels seen before the Federal Reserves started its monetary policy tightening cycle in 2022, according to a new report by the Federal Reserve Bank of New York.

“Standard metrics point to an improvement in Treasury market liquidity in 2024 to levels last seen before the start of the current monetary policy tightening cycle.” Michael Fleming, head of Capital Markets Studies in the NY Fed’s Research and Statistics Group, said in a post on the New York Fed’s Liberty Street Economics blog on Monday.

“Volatility has also trended down, consistent with the improved liquidity. While at least one market functioning metric has worsened in recent months, that measure is an indirect gauge of market liquidity and suggests a level of current functioning that is far better than at the peak seen during the global financial crisis (GFC).”

The US Treasury securities market is the largest and most liquid government securities market in the world, with over $27 trillion in marketable debt outstanding as of August 31, 2024.

Treasury securities serve as a cornerstone of the US financial system. The Treasury Department uses them to fund government operations, while financial institutions rely on them to manage interest rate risk and price other financial instruments.

Having a liquid market is essential to perform all of these purposes and is thus of keen interest to market players and policymakers alike.

Fleming indicated that liquidity in the US Treasury market has improved significantly since early 2023. Key indicators, such as bid-ask spreads, order book depth, and price impact, have returned to levels seen before the Federal Reserve began raising interest rates to curb inflation.

While these improvements are encouraging, concerns remain about the market’s long-term resilience. Recent reforms have helped to enhance trading conditions, but vulnerabilities exposed during previous crises, like the 2020 pandemic, could resurface under certain circumstances.

A key concern is the growing supply of government debt. As the outstanding debt continues to increase, the market’s ability to handle large trading flows may be tested. Ongoing monitoring and efforts to improve the market’s resilience are crucial to ensure its stability.

Attribution: The Federal Reserve Bank of New York