JPMorgan Says Treasuries Handle Worst Liquidity Since 2020

(Bloomberg) — The Federal Reserve may put aside low liquidity in the Treasury market and continue raising rates, JPMorgan Chase & Co. strategists say.

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While the world’s largest bond market has recently experienced some illiquidity, the impact on prices is not as severe as it was during the start of the pandemic, according to a note released Tuesday by a team that includes Jay Barry. Thus, this does not affect financial stability, and the Fed will take this difference into account when deciding whether to raise rates, they said.

“The footprint of each transaction in the market, as measured by the impact on the price, has increased over the past year, but has not increased markedly in recent weeks and remains below crisis levels,” the analysts write. “The dislocations have increased, but are far from disastrous levels.”

US bonds have taken a hit this month as the global banking crisis cast doubt on the Fed’s policy stance and is comparable to it by announcing its latest interest rate decision on Wednesday. But while the closely watched measure of Treasury bond volatility has skyrocketed to its pandemic peak, a measure of the market’s liquidity squeeze has yet to break 2020 highs.

Changes in market structure, the fact that liquidity problems are not widespread across the curve, and Treasury demand trends are likely factors, according to JPMorgan.

Funds betting on the Fed’s aggressive rate hike faltered last week as a banking crisis in US regional banks raised trade doubts. The sharp price fluctuations in short-term interest rate futures last Wednesday also led to a temporary halt in trading in some contracts that were used to bet on the Fed’s policy.

The swap markets are now signaling an 80 percent chance of a quarter-point Fed rally this month, the first time since the start of the current bull cycle a year ago that traders have not fully appreciated even one full move. The interest-sensitive two-year bond yield fell to 4.12% on Wednesday after falling from 5.08% earlier this month after the collapse of Silicon Valley Bank triggered a wave of financial turmoil.

“We expect the Fed to raise rates by 25 basis points and Powell to distinguish between monetary policy decisions and financial stability actions at a press conference,” the strategists wrote.

Treasury bonds maturing between 7 and 10 years have seen the most liquidity crunches, suggesting that this is where the bulk of the liquidations are taking place, the JPMorgan team writes.

“Treasury market liquidity has deteriorated amid high volatility, but we do not view low liquidity as a source of concern for financial stability,” they said.

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