You may have a headache if you’ve been trying to make sense of moves in the $12.6 trillion U.S. government-bond market over the past few weeks.
Treasury yields have gotten pretty jumpy, partly in response to turmoil in Greece, which is teetering on the brink of insolvency, and China’s $3.9 trillion stock-market rout. But there’s another reason for the increased volatility: Wall Street’s biggest dealers slashed their holdings of the securities the most this year to reduce risk heading into the end of the second quarter.
Primary dealers that trade with the Federal Reserve reduced their holdings of the debt by $20.8 billion, to $9.3 billion, in the week ended July 1, Fed data show. That’s the second-lowest the Treasury inventories have been since 2011.
“Smaller holdings typically mean less ability to trade heavily,” said Aaron Kohli, an interest-rate strategist BNP Paribas SA in New York. “It’s happening at a time when liquidity is already bad. It leads to choppy price action.”
Wall Street’s biggest banks typically reduce the amount of risk on their books at seminal times of the year, such as the end of a year or the end of a three-month period for reporting earnings, he said.
This year is no different. Take the first quarter: the 22 primary dealers cut U.S. government-bond holdings by $29.5 billion in the three weeks ended April 1, to $14.7 billion, Fed data show. The last time the biggest banks held a lower volume was the week ended Dec. 31.
The latest pull-back by dealers coincided with some of the biggest macroeconomic drama of the year. Greece has been threatening to be the first nation to exit Europe’s shared currency. Puerto Rico is questioning whether it can repay more than $70 billion of debt. And China’s stock market entered a free-fall that prompted government officials to halt trading in many of the securities for months.
Such uncertainties have certainly loomed over markets of late, leading some investors to seek a haven in U.S. government debt.
On the flip side, the U.S. economy still seems to be improving and the Fed’s still signaling it’s on track to raise interest rates this year for the first time since 2006. That would imply higher yields and lower Treasury prices.
The mood shifts have led to some flipping and flopping in the world’s deepest debt market.
Yields on U.S. 30-year Treasury bonds surged the most in two years Thursday after falling for four straight days. Yields on two-year notes have jumped more than seven basis points in the past two days after plunging almost 15 basis points in the prior four days.
Perhaps a bit of this can be blamed on the banks. While they’ve traditionally buffered big price swings by buying and selling larger chunks of debt from clients, they’ve curtailed inventories in response to risk-curbing rules crafted after the 2008 financial crisis.
“Lower holdings means more friction in trading,” Kohli said.