Waters for Treasury Market Grow Shallow


Written by: Jon McGraw

The U.S. Treasury market is a bit like a lake in the midst of a drought. All the actionfish, frogs, crawdads and suchthat was once hidden in the depths has become a lot more visible as the water shallows.

For decades, traders and investors have turned to U.S. government debtTreasury bills and bondsbecause the market was so deep that hefty trades could be placed without triggering significant price changes, Bloomberg explained. That’s one reason U.S. Treasuries have long been sought as a safe haven in tumultuous times.

Recently, however, the U.S. Treasury market has become more responsive to trades. The yield on 10-year Treasuries rose above 2.3 percent last Tuesday for the first time in months before closing lower on Friday. Some theorize yields are being pushed higher as investors try to stay ahead of Federal Reserve activity or changing inflation expectations, but others say the issue is liquidity.

Liquidity is the ease with which traders can buy and sell bonds. In a highly liquid market, bonds can be bought and sold easily. In a less liquid market, trading becomes more challenging. Bloomberg contends the U.S. Treasury has become less liquid because of financial regulations that were adopted after 2008 to reduce risk taking. The regulations have made bond dealers less willing to hold inventory and facilitate trades. Liquidity also was affected by the Fed, which bought lots of government bonds in its effort to stimulate the economy.

Bloomberg said, “How much depth has the market lost? A year ago, you could trade about $280 million of Treasuries without causing prices to move, according to JPMorgan Chase & Co. Now, it’s $80 million.”

Treasury market volatility had little effect on U.S. stock markets, which finished the week higher.

*U.S. Treasuries may be considered safe haven investments but do carry some degree of risk, including interest rate, credit and market risk.

Data as of 5/15/15 1-Week Y-T-D 1-Year 3-Year 5-Year 10-Year
Standard & Poor’s 500 (Domestic Stocks) 0.3% 3.1% 13.5% 16.9% 13.3% 6.2%
Dow Jones Global ex-U.S. 1.3 9.3 1.8 9.8 5.9 4.1
10-year Treasury Note (Yield Only) 2.1 NA 2.5 1.8 3.5 4.1
Gold (per ounce) 2.9 1.8 -6.0 -7.8 -0.3 11.3
Bloomberg Commodity Index 1.2 1.0 -22.4 -7.7 -3.4 -3.3
DJ Equity All REIT Total Return Index 0.7 0.6 13.3 12.3 13.7 8.4

Debt, Debt, Debt, Debt

The world’s debt is 286 percent of its GDP, according to The Economist. GDP stands for gross domestic product, which is the value of all goods and services produced in a country or region.

So the world owes almost three times the value of what it produces. For the most part, governments have incurred the debt as they’ve tried to help their countries recover from the financial crisis and subsequent recession. A 2015 McKinsey and Company report explained it like this:

“Seven years after the bursting of a global credit bubble resulted in the worst financial crisis since the Great Depression, debt continues to grow. In fact, rather than reducing indebtedness, or deleveraging, all major economies today have higher levels of borrowing relative to GDP than they did in 2007. Global debt in these years has grown by $57 trillion, raising the ratio of debt to GDP by 17 percentage points. That poses new risks to financial stability and may undermine global economic growth.”

McKinsey’s findings show some types of debt grew more slowly from 2007 to 2014 as compared with 2000 to 2007. Increases in household debt and financial debt growth rates (8.5 percent to 2.8 percent and 9.4 percent to 2.9 percent, respectively) slowed sharply.

Other types of debt grew faster. Corporate debt grew at a slightly faster pace during the period (5.7 percent to 5.9 percent), while government debt grew rapidly (5.8 percent to 9.3 percent).

Higher government spending was welcomed in the depths of the recession when it served as a counterbalance to low spending in the private sector. Now, however, government debt levels are becoming a concern. McKinsey reported government debt has risen to such high levels in Spain, Japan, Portugal, France, Italy and the United Kingdom that unusual measures may be needed to reduce debt.

The most obvious way to decrease debt is to trim annual spending—also known as reducing the fiscal deficit—but that could be counterproductive since it often inhibits economic growth, and encouraging growth was the point of taking on debt in the first place. McKinsey recommends alternatives such as “extensive asset sales, one-time taxes on wealth, and more efficient debt-restructuring.”

Weekly Fun—Think About It

“Culture makes people understand each other better. And if they understand each other better in their soul, it is easier to overcome the economic and political barriers. But first they have to understand that their neighbour is, in the end, just like them, with the same problems, the same questions.”

—Paulo Coelho, Brazilian novelist