It’s getting easier for a smaller group of bulls in the U.S. Treasury market to create angst for the bears.
That’s because government-debt trading volumes have slumped to 18 percent below the decade-long average, Federal Reserve data show. As Brean Capital LLC’s Peter Tchir wrote this week: “There is no liquidity even in the mighty Treasury market.”
So as 10-year Treasury yields plunged toward the lowest level in almost a year, a smaller group of active traders may have had a much bigger influence over the $12 trillion market that determines rates on everything from auto loans to corporate debt.
The move in government bonds has defied predictions from Wall Street’s biggest banks for higher borrowing costs, with 10-year Treasury yields falling to 2.47 percent from 3 percent at the end of 2013.
“With less trading capital to commit in fixed income, the dominant flow can appear bigger than it actually is,” Jim Vogel, a fixed-income strategist at FTN Financial in Memphis, Tennessee, wrote in a May 28 note.
U.S. government-bond trading has declined even as the size of the market tripled in the last decade. Trading volumes fell to an average $429 billion a day in the week ended May 21, Fed data show. That’s down from daily averages of $502 billion this year and about $566 billion back in 2007.
One reason for the slowdown is there aren’t as many obvious sellers of the notes. The Fed has been buying U.S. bonds for years, making it the biggest single owner of the debt. Other central banks have locked the bonds away in their vaults across the globe.
Another reason is banks have less incentive to trade the debt. They’re reducing fixed-income inventories in response to risk-curbing regulations, such as the U.S. Dodd-Frank Act’s Volcker Rule, which limits the amount of their own money they may use to buy and sell riskier securities. Many are paring fixed-income staff, too, in the face of lower trading revenues.
While banks can still trade government bonds on economic views, the risk management necessary is expensive and the opportunities limited, Vogel wrote in his note.
“The default choice is to trade less, a simple conclusion based on continuing bank layoffs on the trading side,” he said.
This week’s drop in borrowing costs was accompanied with much hand-wringing, with Loews Corp. Chief Executive Officer Jim Tisch saying yesterday levels are “too damn low,” and that a 2.4 percent yield on 10-year Treasuries “just makes no sense to me.”
Perhaps it’ll only take a few big investors who feel the same way to send Treasury yields higher. Or, we might just be stuck in a slow-moving, low-rate world for longer than many can stand.