...The $12.3 trillion market is also the world’s biggest for government bonds, exceeding the size of the next two nations combined and making it the haven of choice for investors seeking safety. During the credit crisis in 2008, Treasuries soared 14 percent, while both investment-grade debt and junk bonds sank.
JPMorgan & Chase Co., a primary dealer, estimates the amount of U.S. debt available to trade at one time without moving prices has plunged 48 percent to $150 million since April. The measure is based on the average size of the best three bids and offers that go through the New York-based bank’s trading desks on a weekly basis.
That, in turn, may undermine the U.S. government’s cost to borrow if investors begin to doubt whether they will still be able to buy and sell Treasuries on a moment’s notice.
Widening Gap
Another consequence of a lack of liquidity and rising volatility was the widening of the bid-ask spread, or the difference in prices or yields between buyers and sellers.
The gap on 10-year notes reached 0.26 basis point versus an average 0.19 point this year and compares with 0.17 point over the past 15 years, according to data compiled by Bloomberg. One basis point equals 0.01 percentage point.
“You’re widening your spreads out and you invoke more of a premium in this situation,” Sean Murphy, a trader at Societe Generale SA, said by telephone from New York. Murphy, who has been trading Treasuries since 1986, said liquidity constraints on Oct. 15 were similar to what happened after Lehman failed in 2008 and Long-Term Capital Management collapsed in 1998.
Diminishing market depth and a surge in volatility were both on display on Oct. 15.
Gripped by concerns over another recession in Europe, slowing economic growth in China and the spread of the Ebola outbreak, demand for haven assets soared. Buying also picked up as bearish traders pushed back their wagers for how soon the Fed would raise interest rates in the face of a global slowdown.
‘Thin Line’
Dealers contended with the onslaught by offering fewer bonds at a given price and demanding wider spreads, which curbed liquidity and made trading more costly.
“There’s a thin line to keeping the customer happy while also giving a level that you can at least get out of without taking a big loss right away,” Jason Rogan, managing director of U.S. government trading at Guggenheim Securities LLC, a New York-based institutional brokerage, said Oct. 22. Rogan’s firm also turned off its automatic pricing on Oct. 15 because “the market was moving too fast for our prices to keep up.”
Those decisions helped to produce swings rarely seen in Treasuries as trading soared to a record. Yields on the 10-year note tumbled 0.34 percentage point to a low of 1.86 percent that day, with most of that drop occurring in a 10-minute span from 9:30 a.m. in New York, before ending the day at 2.14 percent.
No Immunity
Adjusted for current yield levels, which are close to historical lows, the magnitude of the intraday decline that day has been exceeded only once in the past half-century, according to data compiled by Bloomberg.
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