J.P.Morgan Weigh In On Continued Impaired Market Depth

J.P.Morgan note that “Treasury market depth has been stuck at levels reserved for the throes of the GFC in late-2008/early-2009 and the onset of the COVID-19 pandemic in Spring 2020. While there is no direct liquidity measure for off-the-run Treasuries, we can also indirectly observe the same dynamic via the root mean square error (RMSE) of our Treasury curve, which measures dispersion relative to our par curve. Historically, we have found that RMSE has been driven by 3 factors in recent years. First, a wider GC/OIS spread tends to increase RMSE as the cost of financing balance-sheet intensive off-the-runs becomes more punitive. Second, dispersion tends to increase as dealers hold less inventory and vice versa: this represents the primary dealer community’s ability to warehouse risk, and dealer inventories have been halved in 2021. Finally, RMSE tends to increase as delivered volatility increases, making it challenging for investors to hold onto less-liquid off-the-runs. The final factor has been a critical driving factor recently: RMSE has made new highs as delivered volatility has outstripped the outsized volatility observed in the spring. While dispersion has increased across the curve, the most aggressive manifestation of this dispersion is evident in off-the-run 20-Year bonds.”