One doesn’t have to look very far to find evidence that the Fed’s monumental attempt to corner the Treasury market is producing all manner of distortions and anomalies.
For example, one could point to episodic instances of acute collateral shortages manifested by "immensely" special repo rates. If that’s too esoteric for you, just go and have a look at a 10Y chart from October 15 of last year and ask yourself what happened there. Put simply, when someone comes along and does a multi-trillion dollar bellyflop into any market - even one that could previously be described as the deepest and most liquid on the planet - there are bound to be far-reaching repercussions for market function and that’s precisely what’s happening, and not only in USTs but in JGBs and most recently in German bunds.
Apparently someone at the NY Fed decided that with everyone in the financial universe suddenly screaming about liquidity (or a lack thereof) it was time to take a cursory look at the issue and make a half-hearted, slightly disingenuous attempt to find out if there’s really a problem.
So that’s exactly what Tobias Adrian, Michael Fleming, Daniel Stackman, and Erik Vogt did. There results are posted on the NY Fed’s blog [2] and we present some of the highlights below.
Bid-ask spreads suggest ample liquidity
One of the most direct liquidity measures is the bid-ask spread: the difference between the highest bid price and the lowest ask price for a security. As shown in the chart below, bid-ask spreads widened markedly during the crisis, but have been relatively narrow and stable since.
[3]
Of course bid-asks aren’t really the best way to assess this - market depth is. That is, the question is this: can you transact in size without accidently causing some kind of catastrophe?
On that question the NY Fed is a bit less optimistic.
But other high-frequency measures point to some deterioration
Other measures paint a less sanguine picture of Treasury market liquidity. The chart below plots order book depth, measured as the average quantity of securities available for sale or purchase at the best bid and offer prices. Depth rebounded healthily after the crisis, but declined markedly during the 2013 taper tantrum and around the October 15, 2014 flash rally. It is not unusually low at present by recent historical standards.
[4]
Measures of the price impact of trades also suggest some recent deterioration of liquidity. The next chart plots the estimated price impact per $100 million net order flow as calculated weekly over five-minute intervals; higher impacts suggest reduced liquidity. Price impact rose sharply during the crisis, declined markedly after, and then increased some during the taper tantrum and in the week including October 15, 2014. The measure remained somewhat elevated after October 15, but is not now especially high by recent historical standards.
[5]
The authors' takeaway from the above is that "high-frequency liquidity measures provide a mixed message regarding the state of Treasury liquidity." And while that doesn't sound particularly comforting, we shouldn't worry because the Fed doesn't think those are actually the right measures. When one looks at another set of indicators, everything is actually ok. To wit: "...the daily measures we consider are more consistent."
As an aside, it would have helped if, in the depth chart shown above, they hadn't plotted the 10Y on the same chart with the 2Y because as you can see from the following, the picture looks a little different when the 10Y is plotted on its own.
All in all, the authors conclude that "the current state of Treasury market liquidity [is] fairly favorable," but do concede that "the events of October 15 and similar episodes of sharp, seemingly unexplained price changes in the dollar-euro and German Bund markets have heightened worry about tail events in which liquidity suddenly evaporates."
Why yes, yes they do "heighten worries" because as you can see from the following, market depth just seems to disappear out of the clear blue nowadays.
[6]
We also noticed that at the end of the article, the authors promise to ferret out the causes of such anomalous events "in a future blog post."
To the NY Fed we say this: we know the good folks at 33 Liberty have more important things to do (like running the equity plunge protection team) than spending time searching for the culprits behind the Treasury flash crash, so we'll go ahead and point you in the right direction. First, look in the mirror, next refer to the graphic shown below.
[7]
Mystery solved. You are welcome.
