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Friday, December 9, 2022

Liquidity in the US Treasury market represents the biggest systemic risk to stocks since the 2007 housing bubble, BofA says | Business Insider

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Declining liquidity in the US Treasury market is one of, if not the biggest systemic risk to financial markets since the housing boom of 2007.

Since the housing boom of 2007, declining liquidity in the US Treasuries market constitutes the greatest systemic danger to financial markets, if not the most. This is according to a note released by Bank of America on Wednesday, which emphasized the significance of the daily operating of the US Treasury market and the importance of its uninterrupted operation.

“The US Treasury market is the most important financial market in the world, as Treasury rates are a fundamental benchmark for pricing virtually all other financial assets,” the G30 stated in a July 2021 report, adding that confidence in the US Treasury market is crucial for the stability of the global financial system.

However, a dilemma is emerging in the US Treasury market since the total amount of cash allotted to market-making has not kept pace with the fast rise of outstanding marketable Treasury debt. A period of illiquidity may occur if trade on the US Treasury market drops while the supply of US Treasuries grows.

“If the Treasury market fails to trade for an extended period, it is likely that corporate, household and government borrowing in securities and loans would cease. It is difficult to imagine the ripple effects on the dollar, equity markets, emerging markets, consumer and business confidence,” BofA said.

In 2007, the housing bubble’s collapse resulted in widespread job losses, foreclosures, and substantial worldwide financial losses as liquidity in the housing market fell. The ripple consequences of a similar event would be enormous. The bank continued, “While this may seem like a horrible science-fiction film, it is regrettably a genuine hazard that has consumed many man-hours over the previous decade with little output from regulators or politicians.”

Concerns about the Treasury market’s liquidity arise when the Federal Reserve starts to reduce its purchases of fixed-income assets. The central bank has around $9 trillion in assets on its balance sheet, including US Treasuries and mortgage-backed securities. And although the Fed has purchased US Treasuries during times of market stress, it is a “difficult long-term option” for the central bank to operate as a buyer-of-last-resort for federal debt, according to BofA.

BofA said, “It is not fundamentally sound for the US public debt to grow more dependent on Fed QE. It is dangerous, in our opinion, to depend only on the Fed to remedy the liquidity, resilience, and operational issues in the Treasury market.” BofA argues that a preferable long-term solution would be establishing a dealer of last resort other than the Federal Reserve, which is bound by its twin mandates of price stability and low unemployment. “We think such an organization should be established before a catastrophe makes it necessary.

Source: https://www.businessinsider.com/biggest-stock-market-risk-declining-liquidity-us-treasuries-housing-bubble-2022-9

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