ADD TREASURY MARKET VOLATILITY TO LIST OF KNOWN UNKNOWNS / THE WALL STREE JOURNAL

ADD TREASURY MARKET VOLATILITY TO LIST OF KNOWN UNKNOWNS

By Jon Hilsenrath
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Bloomberg  

Financial regulators are putting out a report Monday about unusual behavior in the $13 trillion U.S. Treasury bond market. As my colleague Katy Burne explains in a WSJ story today, trading in the market has grown thin and prone to unpredictable lurches in bond yields. It has regulators worried, because it could lead to volatility that hurts the economy and markets when the Fed starts raising interest rates. 

Treasury market gyrations on October 15 have gotten a great deal of attention and will be the focus of the report. But as Fed Governor Lael Brainard noted in a recent speech, it wasn’t an isolated event. Late on March 18, the day of a Fed policy meeting, the U.S. dollar depreciated against the euro by 1.75% in less than three minutes, a large drop in a short interval. A few weeks later, German bunds yields swung wildly at a time of little market news. And before all that there was the “taper tantrum” of 2013 when U.S. Treasury yields shot up as the Fed considered ending its bond-buying program.

The regulators themselves might be a cause of the problem. New rules on capital and liquidity for banks have made them reluctant to hold much bond inventory and play aggressively as middlemen in the market, making it less liquid and harder to clear very big trades by investors.

So will the report shoulder the blame for this new market risk? Don’t count on it.

“Reductions in broker-dealer inventories occurred prior to the passage of the Dodd-Frank Act, suggesting that factors other than regulation may also be contributing,” Ms. Brainard said.

Instead, they seem likely to file this under the category of what former Defense Secretary Donald Rumsfeld once called “known unknowns,” problems they know are lurking, but don’t know how to explain, fix or predict.