The Essence of the Piece
The Fed conducted a study on Treasury market liquidity during the height of the COVID-19 crisis. They found that trading algos used by principal trading firms didn’t provide liquidity during the crisis as many had hoped. Instead, market depth disappeared, and bid-ask spreads surged and became more volatile. The Fed also found a big deterioration in the usually very liquid FX markets. This adds to the growing case for understanding how bouts of illiquidity are one the biggest risks for investors.
The Structure of Treasury Markets
The US Treasury market is one of the most liquid markets for government securities in the world. Within that market, the ‘dealer-to-dealer’ (interdealer) segment, rather than the ‘dealer-to-client’ segment, is thought to be the most liquid. Moreover, most of the interdealer flows occur over electronic trading platforms such as BrokerTec and Dealerweb. And with the growth of such platforms, there’s also been a big increase in non-bank dealers or principal trading firms (PTFs). They employ high-speed automated trading strategies and often account for over half the trading volumes on the platforms. In this context, the Fed researchers analysed Treasury market conditions in the interdealer market over March.
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