JPMorgan Says Treasuries Coping Amid Worst Liquidity Since 2020

(Bloomberg) — The Federal Reserve can look past low liquidity in the Treasuries market and continue with its rate hikes, according to strategists at JPMorgan Chase & Co.

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While the world’s biggest bond market endured some illiquidity recently, the impact on prices isn’t as severe as during the onset of the pandemic, according to a note Tuesday from a team including Jay Barry. As such, it’s not affecting financial stability and the Fed will make that distinction when deciding on its rate hikes, they said.

“The footprint of each trade in the market, as measured by price impact, has been elevated for the past year but has not risen appreciably in recent weeks and remains below crisis levels,” the analysts wrote. “Dislocations have increased but are far from distressed levels.”

US bonds have been whiplashed this month as a global banking crisis called into question the policy path for the Federal Reserve and peers with the former due to announce its latest rate decision Wednesday. But while a closely-watched gauge of Treasuries volatility has rocketed past its pandemic high, a measure of liquidity stress in the market has yet to breach its 2020 highs.

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

Funds betting on aggressive rate hikes by the Fed were rocked last week when the banking crisis at US regional banks spurred doubts on the trade. Wild price swings in short-term interest-rate futures last Wednesday had also led to a temporary halt in trading in some contracts used to bet on the Fed policy path.

Swaps markets now signal 80% odds for a quarter-point increase by the Fed this month, the first time since the start of the current hiking cycle a year ago that traders aren’t fully pricing in at least one full move. The rate-sensitive two-year yield dipped to 4.12% Wednesday, having slumped from 5.08% earlier this month after the collapse of Silicon Valley Bank sparked a wave of financial turmoil.

“We look for the Fed to hike by 25 basis points and for Powell to distinguish between monetary policy decisions and financial stability actions in the press conference,” the strategists wrote.

Treasuries with maturities between 7 and 10 years have seen the largest liquidity dislocations, suggesting that is where the bulk of liquidations are occurring, the JPMorgan team wrote.

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