An explosion of volatility in US Treasuries following the collapse of Silicon Valley Bank has provided the sternest test of a market that underpins much of the global financial system since a dramatic meltdown in the early stages of the Covid-19 pandemic.
But while the $22tn market for US government debt this week suffered its most volatile period since the global financial crisis a decade and a half ago, surpassing even levels seen in March 2020, investors and analysts said market functioning by and large held up.
Daily trading volumes more than doubled as the failure of SVB sparked a headlong dash into the safety of Treasuries. Bets that the banking crisis would force the Federal Reserve to slow, or even call off, its plans to raise interest rates further fuelled demand, leading to the biggest one-day rally in short-term Treasuries since 1987.
The moves did not lead to a 2020-style breakdown, when investors began to flee Treasuries en masse in a grave threat to the functioning of the entire financial system until the Fed stepped in with massive bond purchases.
“To me, it felt like the market worked. It functioned,” said Kevin McPartland, head of market structure and technology research at Coalition Greenwich. “The market structure clearly kept up, with $1.5tn traded.”
Still, the current turmoil underlines that frenzied volatility is the new normal in the Treasury market, sparking concerns in some quarters that the potential for a financial accident is never far away.
“We’re one crisis away from a complete breakdown of Treasury market liquidity,” said Priya Misra, head of global rates research at TD Securities. The bailout for SVB depositors and emergency funding measures launched by US authorities “prevented a bigger crisis from happening”, she added.
Almost $1.5tn was traded in Treasuries on Monday with more than $1tn traded on each of the following three days, according to Trace data. That is more than double the recent average daily volume, which in January and February was about $650bn, according to Sifma.
Volatility in the market, tracked by the Ice BofA Move index, reached its highest level since 2008.
There were signs of stress. Liquidity, the ease with which assets can be bought and sold, deteriorated, and investors reported having to pay more to get big deals done. Some traders resorted to picking up the phone to make deals, rather than trading electronically, as they typically do.
“Funding pressures and liquidity pressures in the banking sector have filtered through to the Treasury market,” said Matthew Scott, head of global rates trading at AllianceBernstein. “It is more expensive to trade, you can trade less.”
But trading was still possible, if costly, Scott said. Liquidity conditions in some parts of the market were the worst they had been since March 2020, but they were nowhere near as bad as they were then, when a breakdown in Treasuries sent markets worldwide into a spiral.
The bank angst has also prompted conversations about more regulation of the financial sector, which could chill participation in the Treasury market. The Financial Times reported earlier this week that Fed officials were reviewing capital and liquidity requirements for midsized banks.
New regulations in the wake of the 2008-09 financial crisis designed to make the banking system more robust are behind some of the increased volatility in Treasuries in recent years, investors have long argued.
Primary dealers — the big banks that transact directly with the Treasury department at bond auctions and were the traditional providers of market liquidity — have stepped back from the market. This is partly because post-crisis rules made it more expensive for them to hold Treasuries, and in part because of a broader change in risk appetite.
As their share of government bond trading declined, hedge funds and high-speed traders took their place, introducing new degrees of leverage risk to the market.
Some experts warn that any further constraints on banks as a result of the current crisis, even if only on smaller players, may have a chilling effect on liquidity, further raising risks.
“Banks are now under the regulatory spotlight with this latest crisis — and primary dealer banks will not get a pass, if anything, the opposite. Regulators will be ruthlessly probing bank balance sheets to satisfy themselves that the biggest banks are completely immunised against failure and capable of supporting themselves and the rest of the financial system,” said Yesha Yadav, a professor at Vanderbilt Law School.
Primary dealers, said Yadav, might therefore now have to be extra careful about how they use their balance sheets to make markets in Treasuries. “It seems likely that we are going to have a really depressing few months for Treasuries liquidity ahead.”
Additional reporting by Katie Martin in London