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BofA Sees 'Non-Functioning Areas' in Treasury Market

The market isn’t in a crisis period like it was in March 2020, but there are pockets of illiquidity, say Bank of America analysts.
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The Treasury market isn’t functioning smoothly, say Bank of America analysts led by Mark Cabana, head of U.S. rates strategy.

The market “isn’t in a crisis period like it was in March 2020, but there are pockets of illiquidity and even non-functioning areas within the Treasury markets that are reminiscent of the peak crisis of 2020,” he wrote in a commentary.

For example, “The 30-year Treasury auction cleared 5 basis points above market levels last week, the largest 30-year ‘tail’ since 2011.”

Volatility is high, and Treasury inflation-protected securities’ (TIPS) break-even levels have been registering large moves on very low volumes, Cabana said.

And, book-order depth for the two-year Treasury futures contract has “collapsed and remained abnormally low,” he said.

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“The Treasury market is unlikely to be a well-functioning market without ongoing official sector support during the taper period and beyond,” Cabana wrote.

“The Fed appears to be aware of this now, based on their adjustment to the Treasury quantitative easing purchase calendar Friday.

“Going forward, it seems likely the Fed will continue supporting the Treasury secondary market through flexibility in their taper schedule, changes to their Treasury rollover process, or by reinvesting maturing mortgage-backed securities into Treasuries.

“We believe the Treasury [Department] should have a larger role in the management of secondary Treasury market trading conditions as well, but acknowledge that Treasury [Department] debt managers have largely abdicated this responsibility to the Fed.”

The Fed said earlier this month that it plans to taper to the tune of $15 billion a month, ending its bond buying around the middle of next year.