Wall Street sounds the alarm over bond liquidity

“We continue to expect treasury market functioning to remain somewhat challenged,” said Praveen Korapaty, chief rates strategist at Goldman Sachs in a note. “In the absence of the Fed’s ‘backstop’ presence, we believe it may take time and greater certainty in the geopolitical outlook for liquidity to materially improve, suggesting ongoing risk of somewhat disorderly yield swings.”

Fears over the microstructure of the debt market are far from new. But geopolitical tensions and oncoming monetary tightening are raising the stakes. 

Among Cabana’s calls on Fed actions are that the Fed’s upcoming debt roll-off — or at least the part of it related to treasuries — could be “delayed and pushed from May to June/July”. He also wants it to replace mortgage debt that is rolling off its balance sheet with treasuries.

Lou Crandall, chief economist at Wrightson ICAP, called on the treasury this week to consider buying back older notes and bonds, such as off-the-run securities that typically trade less frequently than newly issued debt.

Citigroup and Wells Fargo strategists have also issued fresh missives of late on declining bond liquidity in notes to clients.

Rising volatility is unmasking deficiencies at the heart of the debt market. Yields have taken a wild ride, with the war triggering a flight-to-quality bid while the Fed’s upcoming tightening plan emboldens bears. 

Benchmark 10-year yields have fallen from over 2%, just before the February 24 Russian invasion of Ukraine, to as low as 1.67% on Monday. 

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