What happened in the U.S. bond market during March 2020
- Price impacts reached their local peaks on March 12 and 13 at levels roughly 5-6 times their post-2007 financial crisis averages.
- Bond volatility reached its highest level in the past fifteen years for the five days ending March 19, and volatility on March 19 was the second highest for a single day over the same period.
- Daily trading volume in the market overall reached a record high for the week ending March 4, averaging over $1 trillion, roughly twice its post-crisis average. High trading volume amid high illiquidity is common in the Treasury market, and was also observed during the market turmoil around the near-failure of Long-Term Capital Management and during the 2007-09 financial crisis.
Treasury Market Liquidity during the COVID-19 Crisis
By: Michael Fleming, Francisco Ruela – Federal Reserve Bank of New York
How did the Fed react?
[T]he Federal Reserve purchased over $1T of Treasuries in the first quarter of 2020, more than in either of the QE1, QE2, or QE3 programs. I argue that Fed purchases were causal for driving down yields by documenting the timing of Fed purchases (which were increased sharply on March 19, the same day the yield spike started to reverse) and the timing of yield reversals and Fed purchases in the MBS market, as well as by providing evidence against confounding factors. The Fed’s “market-functioning” QE during COVID appears to have worked more via purchase effects than announcement effects, in contrast to earlier QE programs and in contrast to corporate bond purchases during the COVID crisis.
[…] With sharply increasing Treasury debt, there is a risk of more frequent Treasury market dislocations. Will the Federal Reserve be able to stabilize the Treasury market even on a very large scale?
The Treasury Market in Spring 2020 and the Response of the Federal Reserve
Author: Annette Vissing-Jorgensen
From: University of California Berkeley
Ten recommendations to reform the U.S. Treasury markets
A working group consisting of prominent economists such as Larry Summers, Masaaki Shirakawa, Kevin Warsh, Arminio Fraga, William C. Dudley, Darrell Duffie, Mervyn King, Jeremy Stein, Guillermo Ortiz and Axel Weber published a special report on how to reform the U.S. Treasury market in order to increase the liquidity of the Treasury market during times of stress. They argue:
The COVID-19 pandemic cast further doubts over the system’s ability to absorb financial trauma and recover. The authors warn that if intermediation is not taken immediately, it could result in permanent damage to the Treasury, impact U.S. fiscal policy for decades, and burden tax-payers. With the root of these shocks still undetermined, there is fear that it will create more dysfunction in the market and drive investors away.
These recommendations include:
- The Federal Reserve should create a Standing Repo Facility (SRF) that provides very broad access to repo financing for U.S. Treasury securities on terms that discourage use of the facility in normal market conditions without stigmatizing its use under stress. It should make permanent its Foreign and International Monetary Authority repo facility.
- All trades of Treasury securities and Treasury repos executed on electronic interdealer trading platforms that offer anonymous trading by interposing an interdealer broker between buyers and sellers should be centrally cleared.
- The SEC [U.S. Securities and Exchange Commission], in consultation with the Federal Reserve and the Treasury, should review the robustness of the prudential safeguards at broker-dealers (including interdealer brokers) in U.S. Treasury securities and Treasury repos that are not affiliated with banks (independent dealers).
U.S. Treasury Markets: Steps Toward Increased Liquidity
Authors: Group of Thirty Working Group on Treasury Market Liquidity
