Bond Trading Just Keeps Getting Worse as Treasury Prices Swing

It’s taking less and less these days to make the $12.5 trillion U.S. Treasury market jump.

And it’s been jumping a lot lately: The bonds gained 2.9 percent in January, then plunged 1.7 percent the following month, according to Bank of America Merrill Lynch’s U.S. Treasury index. That 4.6 percentage-point swing in returns was the biggest to start any year since at least 1978.

All of this has happened as trading declined. In the first two months of the year, activity at primary dealers dropped to an average $511 billion a day, down 1 percent from the same period in 2014 and 7 percent from a year before that. Those declines mean fewer trades are moving the needle on government rates that serve as benchmarks for auto loans, corporate debt and mortgages.

On March 6, for example, 10-year Treasury yields rose the most in a month after a jobs report that was better than analysts expected. Trading volumes, though, were about 20 percent lower that day, “amplifying volatility,” Jim Vogel, an interest-rate strategist at FTN Financial wrote in a note last week. “For a big payroll day, volume was oddly subdued.”

This has potentially big consequences when that bear market in bonds finally arrives. When investors do start shifting around their holdings more, prices will probably be even more volatile, according to Boris Rjavinski, a strategist at UBS Group AG .

“In a situation where the market is moving quickly and someone is looking to get out, there will be a real price for liquidity,” Rjavinski said in a telephone call.

The Treasury market, often thought of as the most liquid market in the world, has slowed down even as the amount of U.S. government debt has almost tripled since 2007. Trading has fallen 11 percent in that period as the world’s biggest banks reduce their inventories to comply with new risk-curbing regulations.

When the Federal Reserve pulls the plug on its record stimulus, the volatility that we’re seeing now may look relatively calm.