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 $22 billion U.S. government debt market this week suffered its most volatile period since the global financial crisis a decade and a half ago, even surpassing levels seen in March 2020, investors and analysts said the market’s functioning was largely holding up.
Daily trading volumes more than doubled as SVB’s failure triggered a headlong rush into Treasury safety. Bets that the banking crisis would force the Federal Reserve to slow, or even halt, its plans to raise interest rates further fueled demand, leading to the biggest one-day rise in short-term Treasuries since 1987.
The moves did not lead to a 2020-style crash, when investors began fleeing Treasuries en masse in a serious threat to the functioning of the entire financial system, until the Fed stepped in with massive bond purchases.
“For me, it felt like the market was working. It worked,” said Kevin McPartland, head of market structure and technology research at Coalition Greenwich. “Market structure clearly kept pace with $1.5tn traded.”
Still, the current turmoil underscores that frenzied volatility is the new normal in financial markets, raising concerns in some quarters that the potential for a financial crash is never far away.
“We are one crisis away from a complete collapse of financial market liquidity,” said Priya Misra, head of global fixed income research at TD Securities. The bailout for SVB depositors and emergency funding measures initiated by US authorities “prevented a major 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 most recent average daily volume, which in January and February was around 650 billion. USD 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, worsened, and investors reported paying more to get large trades done. Some traders resorted to picking up the phone to make trades instead of trading electronically as they typically do.
“Funding pressures and liquidity pressures in the banking sector have filtered through to the financial market,” said Matthew Scott, head of global fixed income trading at AllianceBernstein. “It’s more expensive to shop, you can shop less.”
But trade was still possible if it was expensive, Scott said. Liquidity conditions in some parts of the market were the worst they had been since March 2020, but they were not nearly as bad as they were when a collapse in government bonds sent markets around the world into a spiral.
The banking anxiety has also given rise to talks about more regulation of the financial sector, which may cool participation in the financial market. The Financial Times reported earlier this week that Fed officials were reviewing capital and liquidity requirements for medium-sized banks.
New regulations in the wake of the 2008-09 financial crisis designed to make the banking system more resilient are behind some of the increased volatility in government bonds in recent years, investors have long argued.
Primary dealers – the big banks that deal 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 the post-crisis rules made it more expensive for them to hold government bonds, and partly because of a wider 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 restrictions on banks as a result of the current crisis, even if only on smaller players, could have a chilling effect on liquidity and further increase risks.
“The banks are now under the regulatory spotlight with this latest crisis – and primary dealer banks will not get a pass, if anything, quite the opposite. Regulators will relentlessly scrutinize bank balance sheets to ensure that the largest banks are completely immune to failure and in able to support itself and the rest of the financial system,” said Yesha Yadav, a professor at Vanderbilt Law School.
Primary dealers, Yadav said, may therefore now need to be extra careful about how they use their balance sheets to make markets in government bonds. “It seems likely that we will have some really depressing months for Treasury liquidity ahead.”
Additional reporting by Katie Martin in London