Anyone wondering whether the Daily Telegraph’s Ambrose Evans-Pritchard is a supporter (at least in current conditions) of Britain’s new prime minister, Rishi Sunak, won’t be left in much doubt after reading his latest piece (paywalled) here.
AEP makes the point that the market panic that followed the Truss/Kwarteng mini budget has quickly subsided. To be sure, it took the installation of a new team in government to do it, but it made a nonsense of all the “irreparable damage” talk from some of the excitable sections of the financial commentariat, particularly those of a leftish orientation.
AEP:
The verdict on British political risk from the trading floors is emphatic. Credit default swaps measuring the likelihood of UK bankruptcy five years ahead have dropped back to 30 points as of this morning, below swaps for France at 34.2, Spain and Portugal 64, Canada 80, China 132, and Italy 163.
Sterling is back to where it was before the mini-budget. Yields on 30-year gilts [British government bonds] have returned to the status quo ante Truss. They have risen less than equivalent US Treasuries since September 23.
The UK has managed to absorb so much global attention with its gilts crisis that few have noticed the parallel and more important convulsions in the US Treasury market.
Even fewer have noticed the vicissitudes playing out in East Asian exchange rates, also pregnant with global menace.
The indexes of liquidity and volatility in the US Treasury market – the anchor of the international system – have reached levels of extreme stress last seen at the onset of the pandemic in March 2020, when the US Federal Reserve had to intervene with emergency injections at colossal scale.
The US Treasury is exploring a ‘buyback’ mechanism to mop up its own debt on the open market, a highly-unusual move intended to prevent the market seizing up due to lack of liquidity. . . .
AEP is not famous for his calm, and I don’t agree with one or two parts of the article, but he is right to cast a nervous eye over the Treasuries market.
Robert Burgess in Bloomberg, October 14:
Liquidity [in the Treasuries market] is quickly evaporating. Volatility is soaring. Once unthinkable, even demand at the government’s debt auctions is becoming a concern. Conditions are so worrisome that Treasury Secretary Janet Yellen took the unusual step Wednesday of expressing concern about a potential breakdown in trading, saying after a speech in Washington that her department is “worried about a loss of adequate liquidity” in the $23.7 trillion market for US government securities. Make no mistake, if the Treasury market seizes up, the global economy and financial system will have much bigger problems than elevated inflation.
A Bloomberg index shows liquidity in the Treasury market is worse now than during the early days of the pandemic and the lockdowns, when no one knew what to expect. Similarly, implied volatility as measured by the ICE BofA MOVE Index is near its highest since 2009. And in an unusual development that shows just how dysfunctional the Treasury market has become, the newest, most liquid securities, known as on-the-run notes, trade at a discount to older, tougher-to-trade off-the-run securities, according to data compiled by Bloomberg. Daily swings in interest-rate swaps have become extreme, proving further evidence of disappearing liquidity.
What should be most concerning to the Fed and the Treasury Department is deteriorating demand at US debt auctions. A key measure called the bid-to-cover ratio at the government’s offering Wednesday of $32 billion in benchmark 10-year notes was more than one standard deviation below the average for the last year, according to Bloomberg News. Demand from indirect bidders, generally seen as a proxy for foreign demand, was the lowest since March 2021, data compiled by Bloomberg show. Although the Treasury is in no jeopardy of suffering a “failed auction,” lower demand means the government is paying more to borrow.
All this is coming as Bloomberg News reports that the biggest, most powerful buyers of Treasuries – from Japanese pensions and life insurers to foreign governments and US commercial banks – are all pulling back at the same time. “We need to find a new marginal buyer of Treasuries as central banks and banks overall are exiting stage left,” Glen Capelo, who spent more than three decades on Wall Street bond-trading desks and is now a managing director at Mischler Financial, told Bloomberg News.
A story in the Washington Post (October 24) gives additional detail, particularly on the question of why liquidity is drying up. The replacement of QE by QT is one obvious reason, but there seems to be more to it than that:
A year of steep losses for bonds caused by rising inflation and Fed interest-rate increases has led many of the traditional big participants, like US commercial banks, foreign governments and life insurers, to shy away from the debt market. Big financial institutions haven’t been as willing to serve as market-makers, burdened by the so-called supplementary leverage ratio, or SLR, which requires that banks set aside capital against such activity.
In part therefore, this appears to be yet another consequence of the move away from ultra-low interest rates.
The article contains details of various steps that the Fed can take to help increase the situation (including a relaxation of the SLR rules) and doubtless those will be forthcoming, but signs that the usual buyers are reluctant to buy are . . . interesting.