Could liquidity dry up in US Treasuries?

Declining liquidity in US Treasuries – the global 'safe-haven' asset – could have unpredictable consequences.

Russ Koesterich, the chief executive investment officer of BlackRock, the world's largest asset manager, is worried, says Szu Ping in The Daily Telegraph.With interest rates set to begin rising again after years at record lows, Koesterich is concerned that "complacent investors could be left floundering in a world of evaporating liquidity" as ultra-easy monetary policies come to an end.

Hedge fund manager Ray Dalio of Bridgewater Associates has gone further; in a recent note, he warned clients that the Federal Reserve risks "triggering a 1937-style stockmarket crisis when it starts to raise rates". Back then, US stocks slumped 55% as policymakers began to wind down the stimulus measures they had introduced in an attempt to lift the economy out of the great depression.

Perhaps the greatest fear is how tighter policy will affect the US bond market. This is "the biggest and most liquid in the world, and forms the bedrock for the global financial system", says the FT's Robin Wrigglesworth.

Yet it experienced unprecedented volatility last autumn, and Federal Reserve officials have warned that this "could happen again due to the changing nature of the US government debt market".

Fears centre on "regulatory changes that encourage the hoarding of Treasuries and discourage banks from helping to cushion sharp moves in bond markets". The rise of "electronic, high-frequency trading in the US government bond market" is another cause for concern. Declining liquidity in US Treasuries the global 'safe-haven' asset could have unpredictable consequences.

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