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Increasing indications of pressure are evident in the $30 trillion U.S. Treasury market, with unrest in the Middle East causing fluctuations in the bonds foundational to the global financial framework.
The ease of transactions in the world’s largest and most crucial financial market has diminished over recent weeks, despite trading remaining active, according to analyses from Wall Street institutions and financiers.
This market tension suggests that some investors are withdrawing from Treasury trading as the conflict in Iran triggers the most significant period of instability since President Donald Trump’s so-called “liberation day” tariff announcement rattled Treasuries last April.
Since the war commenced four weeks prior, Treasury yields have fluctuated widely on numerous days as investors re-evaluate how extensively surging oil prices will contribute to inflation and impact the Federal Reserve’s interest rate outlook.
Treasuries experienced a sell-off on Thursday, with the two-year yield, sensitive to monetary policy, rising by 0.12 percentage points to 4 percent. This month, the two-year yield has surged by 0.62 percentage points, putting it on track for its poorest performance since September 2022, while a recent auction of the same debt earlier in the week garnered a lukewarm reception.
“Investors remain uncertain whether the peak of the conflict has been reached, which has prompted individuals to remain on the sidelines,” stated Meghan Swiber, a U.S. interest rate expert at Bank of America.
Liquidity, referring to the facility with which traders can purchase or divest, “in rates and macro products has worsened over the past month,” added Matthew Scott, who directs core fixed income and multi-asset trading at AllianceBernstein.
JPMorgan Chase similarly observed this week that the magnitude of trades necessary to influence prices, referred to as “market depth,” has decreased by nearly as much as it did following Trump’s liberation day declaration.
Financiers and policymakers meticulously monitor the Treasury market’s performance, as it serves as a vital benchmark for global borrowing expenses.
While the market’s functionality had declined, investors and other market participants indicated that substantial trades were still feasible.
The reduction in market depth was “a natural reaction to an external shock when participants withdraw,” commented James Carter, co-head of fixed income at investment management firm W1M. “Historically, such periods tend to be brief.”
With such volatility pushing traders to the periphery, market depth in the cash market has decreased by approximately 40-50 percent compared to pre-conflict levels, according to Scott at AllianceBernstein.
In short-dated bond futures, which are derivative instruments frequently employed to speculate on or protect against bond movements, market depth has fallen by up to 80 percent this week compared to this year’s average, as reported by an executive at a prominent asset management company.
U.S. equity market liquidity, too, was “exceptionally scarce,” Scott Rubner, Citadel Securities’s head of equity and equity derivatives strategy, noted in a report this week. Reduced liquidity, particularly at the highest tier of the order book—representing the most favorable prices available for buying and selling—“impedes the capacity to swiftly shift risk without consequences,” he elaborated.
Market volatility has dramatically escalated since the war’s inception, but Treasury trading became particularly difficult on Monday after Trump posted on Truth Social early in the day that the U.S. had engaged in “fruitful” discussions with Iran, only for Tehran to subsequently deny any such talks.
The turbulence in Treasuries was so severe that some major Wall Street financial institutions disabled the screens they utilize for automatic price quotations, compelling buyers to revert to slower, manual, human-to-human transactions.
“On Monday morning, following the immediate shock from the Truth Social post, electronic trading was disrupted. Dealers were observed turning off autoquotes on Treasuries,” remarked Michael Lorizio, a senior fixed-income trader at Manulife Asset Management, who pointed out that investors had briefly “struggled to value” some Treasury securities.
Inflation-indexed Treasuries and shorter-term notes have been especially impacted because they are most responsive to inflation and monetary policy expectations, respectively. Traders in the futures market now anticipate the Fed is more likely to increase rates than to decrease them this year, in contrast to having priced in two-three cuts prior to the conflict.
U.S. government sales of new shorter-term bonds this week have also fared poorly. During Tuesday’s offering of $69 billion worth of two-year bonds, dealers—the major banks obligated to absorb any bonds not purchased by investors—acquired the largest proportion of the issuance since 2022.
A similar trend was observed at Wednesday’s sale of $70 billion of five-year notes, where dealers bought the most since 2024. An auction of seven-year notes on Thursday showed moderate improvement, yet remained substandard by historical measures.
Further contributions from George Steer, Harriet Clarfelt and Michelle Chan in New York