William John Market Report 02-09-21
William John looks at the low volume of the US Treasury Market in August and how this impacts bondholders and the wider economy.
William John, Bonds, Treasuries, Capital Markets, Market Making

William John Market Report 02-09-21

William John Market Report 02-09-21

Category: Reports

The U.S. government bond market underpins the global financial system. Considered the safest publicly listed investment available to investors, there are currently $21.7 trillion worth of outstanding U.S. Treasury securities worldwide. Additionally, yields on medium to long term maturity Treasury bonds are used as proxies for the “risk-free” rate of return which is used in asset pricing models to help investors build their portfolios and acts as a benchmark to evaluate the rates of return of many other assets. In other words, every investor worldwide in some manner or fashion relies on these securities. 

August is an interesting month for the U.S. Treasury market because it is a month whereby, typically, trading volumes of the securities – the amount a particular security has been traded during a given period of time – are low. According to the Financial Times, Goldman Sach’s liquidity index for 5- and 10-year Treasury bonds fell well below their 21-day average. Meanwhile, JP Morgan Asset Management reported that the market depth of U.S. Treasury bonds had fallen to its lowest level since March. Market depth measures the number of standing orders to buy and sell U.S. treasuries at various prices – another measure of market trading volume. 

When market volume is low (or lower than usual), the bid-ask spread of securities tends to widen. The spread is the difference between the “Bid”, the price a trader is willing to pay for a security and the “Ask”, the price a trader is willing to sell a security. Typically, U.S. treasuries are so actively traded (one of if not the most traded securities in the world) that the bid-ask spread on various maturities of these securities is very narrow. However, according to Morgan Stanley, bid/ask spreads for 10-year Treasury bonds and 30-year Treasury bonds in early August hit a 5 and a half month high. 

With low market volume and widening bid-ask spreads, this causes the usually highly liquid and safe Treasury market to become volatile and affected by individual trades. Observing the CBOE Volatility Index for 10-year U.S. Treasuries:


Source: William John Analytics, Federal Reserve of St. Louis

Clearly, over the past two months or so, the volatility of 10-year U.S. treasuries (as an example) has increased by approximately a third, from a level of just above 10 in July to above 15 ten days ago. 

Volatile Treasury prices are likely to concern investors, who have been purchasing the risk-averse securities among an uncertain macroeconomic environment: mounting pressure on the Federal Reserve to taper its asset purchases to reduce inflationary pressure and the continuing economic fallout of COVID impacting employment. Investor purchases of 10-year treasuries have sent the yield, which moves inversely to price, on the bonds down since mid-May:

Source: William John Analytics, Financial Times

Investors find themselves in a predicament whereby their risk aversion has drawn them to purchase large quantities of Treasuries, depressing yields, but has exposed them to high price volatility due to the nature of the August Treasury market. Hopefully spreads narrow back to their stable levels in September and the market rebalances in a pivotal moment for capital markets with monetary policies on the verge of being adapted and the wider economy in an almost-complete recovery cycle. 

Any opinions expressed in these documents are those of William John and are provided for information only. E&OE.