In a 2022 submit, we confirmed how liquidity circumstances within the U.S. Treasury securities market had worsened as provide disruptions, excessive inflation, and geopolitical battle elevated uncertainty concerning the anticipated path of rates of interest. On this submit, we revisit some generally used metrics to evaluate how market liquidity has developed since. We discover that liquidity worsened abruptly in March 2023 after the failures of Silicon Valley Financial institution and Signature Financial institution, however then shortly improved to ranges near these of the previous yr. As in 2022, liquidity in 2023 continues to intently observe the extent that will be anticipated by the trail of rate of interest volatility.

Significance of Treasury Market Liquidity

The U.S. Treasury securities market is the most important and most liquid authorities securities market on the earth, with greater than $25 trillion in marketable debt excellent (as of August 31, 2023). The securities are utilized by the Treasury Division to finance the U.S. authorities, by numerous monetary establishments to handle rate of interest threat and value different monetary devices, and by the Federal Reserve in implementing financial coverage. Having a liquid market is essential for all of those functions and thus of concern to market members and policymakers alike.

Measuring Liquidity

Liquidity typically refers to the price of shortly changing an asset into money (or vice versa) and is measured in varied methods. We have a look at three generally used measures, estimated utilizing high-frequency information from the interdealer market: the bid-ask unfold, order e-book depth, and value influence. The measures are estimated for essentially the most lately auctioned (on-the-run) two-, five-, and ten-year notes (the three most actively traded Treasury securities, as proven in this Liberty Avenue Economics submit), and are calculated for New York buying and selling hours (outlined as 7 a.m. to five p.m.).

Market Liquidity Worsened in March 2023

The bid-ask unfold—the distinction between the bottom ask value and the best bid value for a safety—is likely one of the hottest liquidity measures. As proven within the chart under, bid-ask spreads widened abruptly after the failures of Silicon Valley Financial institution (March 10) and Signature Financial institution (March 13), suggesting decreased liquidity.  For the two-year notice, spreads exceeded these noticed throughout the COVID-related disruptions of March 2020 (examined in this Liberty Avenue Economics submit). Spreads then narrowed over the next month or so to ranges near these of the previous yr however remained considerably elevated for the two-year notice.

Bid-Ask Spreads Widened in March 2023

Supply: Creator’s calculations, based mostly on information from BrokerTec.
Notes: The chart plots five-day transferring averages of common day by day bid-ask spreads for the on-the-run two-, five-, and ten-year notes within the interdealer market from September 1, 2019 to September 30, 2023. Spreads are measured in 32nds of some extent, the place some extent equals one p.c of par.

The subsequent chart plots order e-book depth, measured as the typical amount of securities out there on the market or buy at the very best bid and provide costs. This metric once more factors to comparatively poor liquidity in March 2023, because the out there depth declined precipitously. Depth within the five-year notice was at ranges commensurate with these of March 2020, whereas depth within the two-year notice was appreciably decrease—and depth within the ten-year notice appreciably increased—than the degrees of March 2020. Inside a few month, depth for all three notes was again to ranges just like these of the previous yr.

Order E-book Depth Plunged in March 2023

Supply: Creator’s calculations, based mostly on information from BrokerTec.
Notes: This chart plots five-day transferring averages of common day by day depth for the on-the-run two-, five-, and ten-year notes within the interdealer market from September 1, 2019 to September 30, 2023. Information are for order e-book depth on the inside tier, averaged throughout the bid and provide sides. Depth is measured in tens of millions of U.S. {dollars} par and plotted on a logarithmic scale.

Measures of the worth influence of trades additionally recommend a notable deterioration of liquidity. The subsequent chart plots the estimated value influence per $100 million in internet order stream (outlined as buyer-initiated buying and selling quantity much less seller-initiated buying and selling quantity). The next value influence suggests decreased liquidity. Value influence for the two-year notice rose sharply in March 2023 to a degree about twice as excessive as at its March 2020 peak, after which inside a month or so returned to ranges similar to these of the previous yr.  Value influence for the five-and ten-year notes rose extra modestly in March.

Value Influence Rose in March 2023

Supply: Creator’s calculations, based mostly on information from BrokerTec.
Notes: The chart plots five-day transferring averages of slope coefficients from day by day regressions of one-minute value modifications on one-minute internet order stream (buyer-initiated buying and selling quantity much less seller-initiated buying and selling quantity) for the on-the-run two-, five-, and ten-year notes within the interdealer market from September 1, 2019 to September 30, 2023. Value influence is measured in 32nds of some extent per $100 million, the place some extent equals one p.c of par.

Volatility Spiked in March 2023

The failures of Silicon Valley Financial institution and Signature Financial institution elevated uncertainty concerning the financial outlook and anticipated path of rates of interest. Rate of interest volatility elevated sharply in consequence, as proven within the subsequent chart, with two-year notice volatility specifically reaching ranges greater than twice as excessive as in March 2020. Volatility causes market makers to widen their bid-ask spreads and submit much less depth at any given value to handle the elevated threat of taking up positions, producing a unfavorable relationship between volatility and liquidity. The sharp rise in volatility and its subsequent decline therefore assist clarify the noticed patterns within the liquidity measures.

Value Volatility Spiked in March 2023

Supply: Creator’s calculations, based mostly on information from BrokerTec.
Notes: The chart plots five-day transferring averages of value volatility for the on-the-run two-, five-, and ten-year notes within the interdealer market from September 1, 2019 to September 30, 2023. Value volatility is calculated for every day by summing squared one-minute returns (log modifications in midpoint costs) from 7 a.m. to five p.m., annualizing by multiplying by 252, after which taking the sq. root. It’s reported in p.c.

Liquidity Continues to Observe Volatility

As in “How Liquid Has the Treasury Market Been in 2022?,” we assess whether or not liquidity has been uncommon given the extent of volatility by inspecting scatter plots of value influence towards volatility. The chart under offers such a plot for the five-year notice, displaying that the 2023 observations (in grey) fall in keeping with the historic relationship. That’s, the affiliation between liquidity and volatility in 2023 has been in keeping with the previous affiliation between these two variables. That is true for the ten-year notice as effectively, whereas for the two-year notice the proof factors to considerably higher-than-expected value influence given the volatility (as additionally occurred in fall 2008, March 2020, and 2022).

Liquidity in Line with Historic Relationship with Volatility

Supply: Creator’s calculations, based mostly on information from BrokerTec.
Notes: This chart plots value influence towards value volatility by week for the on-the-run five-year notice from January 1, 2005, to September 30, 2023. The weekly measures for each collection are averages of the day by day measures plotted within the previous two charts. Fall 2008 factors are for September 21, 2008–January 3, 2009, March 2020 factors are for March 1, 2020–March 28, 2020, 2022 factors are for January 1, 2022–December 31, 2022, and 2023 factors are for January 1, 2023–September 30, 2023.

The previous evaluation relies on realized value volatility—that’s, on how a lot costs are literally altering. We repeated the evaluation with implied (or anticipated) rate of interest volatility, as measured by the ICE BofAML MOVE Index, and located comparable outcomes for 2023. That’s, liquidity for the five- and ten-year notes is in keeping with the historic relationship between liquidity and anticipated volatility, whereas liquidity is considerably worse for the two-year notice.

Continued Vigilance

Whereas Treasury market liquidity has not been unusually poor given the extent of rate of interest volatility, continued vigilance by policymakers and market members is acceptable. The market’s capability to easily deal with massive buying and selling flows has been of concern since March 2020, as mentioned in this Brookings paper. Furthermore, new empirical work exhibits how constraints on intermediation capability can exacerbate illiquidity. Cautious monitoring of Treasury market liquidity, and continued efforts to reinforce the market’s resilience, are warranted.

Photo: portrait of Michael Fleming

Michael J. Fleming is the top of Capital Markets Research within the Federal Reserve Financial institution of New York’s Analysis and Statistics Group. 

Find out how to cite this submit:
Michael Fleming, “How Has Treasury Market Liquidity Advanced in 2023?,” Federal Reserve Financial institution of New York Liberty Avenue Economics, October 17, 2023, https://libertystreeteconomics.newyorkfed.org/2023/10/how-has-treasury-market-liquidity-evolved-in-2023/.


Disclaimer
The views expressed on this submit are these of the writer(s) and don’t essentially replicate the place of the Federal Reserve Financial institution of New York or the Federal Reserve System. Any errors or omissions are the duty of the writer(s).

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