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The $30tn US Treasury market is showing growing signs of strain, as turmoil in the Middle East drives swings in bonds that underpin the financial system.
The ease of trading in the world’s biggest and most important financial market has deteriorated in recent weeks, even as dealing remains fluid, according to Wall Street banks and investors.
The pressure in markets suggests some investors are pulling back from trading Treasuries as the war in Iran prompts the most serious bout of volatility since President Donald Trump’s so-called liberation day tariff announcement shook Treasuries last April.
Treasury yields have moved in a wide range on many days since the war began four weeks ago as investors reassess the extent to which soaring oil prices will bleed into inflation and affect the Federal Reserve’s rate outlook.
Treasuries sold off on Thursday, with the monetary policy-sensitive two-year yield up 0.12 percentage points to 4 per cent. The two-year yield has soared 0.62 percentage points this month, on track for its worst performance since September 2022, while an auction of the same debt earlier this week received a dull reception.
“Investors aren’t sure whether we have hit peak conflict yet, and that has kept people on the sidelines,” said Meghan Swiber, a US interest rate analyst at Bank of America.
Liquidity, the ease with which traders can buy or sell, “in rates and macro products has deteriorated over the last month”, added Matthew Scott, head of core fixed income and multi-asset trading at AllianceBernstein.
JPMorgan Chase similarly noted this week that the size of trades required to move prices, known as “market depth”, has fallen by nearly as much as it did following Trump’s liberation day announcement.
Investors and policymakers keep close tabs on the Treasury market’s functioning since it acts as vital benchmark for global borrowing costs.
While functioning of the market had worsened, investors and other market participants said it was still possible to make large trades.
The decline in market depth was “a natural response to an exogenous shock when participants step back”, said James Carter, co-head of fixed income at investment manager W1M. “Historically that tends to be short-lived.”
With that volatility driving traders to the sidelines, market depth has declined by roughly 40-50 per cent in the cash market compared to prewar levels, according to Scott at AllianceBernstein.
In shorted-dated bond futures, derivatives that are widely used to bet on or hedge against moves in bonds, market depth has declined by as much as 80 per cent this week compared to this year’s average, according to an executive at a large asset manager.
US stock market liquidity, too, was “extremely thin”, Scott Rubner, Citadel Securities’s head of equity and equity derivatives strategy, said in a note this week. Lower liquidity, particularly at the top of the order book — representing the best available prices to buy and sell — “hinders the ability to move risk quickly without impact”, he added.
Volatility across markets has risen dramatically since the start of the war, but Treasury trading became especially fraught on Monday after Trump wrote on Truth Social early in the day that the US had held “productive” talks with Iran, just for Tehran to later say there had been no discussions.
The tumult in Treasuries was so severe that some big Wall Street banks turned off the screens they use to automatically quote prices, forcing buyers to revert to slower manual human-to-human trading.
“Monday morning after the initial immediate shock from the Truth Social post, you saw electronic trading disrupted. You saw dealers turn off autoquotes on Treasuries,” said Michael Lorizio, senior fixed-income trader at Manulife Asset Management, who noted that investors had briefly “struggled to price” some Treasury securities.
Inflation-protected Treasuries and shorter-dated notes have been particularly affected because they are most sensitive to inflation and monetary policy expectations, respectively. Traders in the futures market are now viewing the Fed as more likely to raise rates than cut them this year, versus having priced in two-three cuts prior to the war.
US government auctions of new shorter-dated bonds this week have also gone poorly this week. At Tuesday’s sale of $69bn worth of two-year bonds, dealers — the big banks that are forced to sop up any bonds not purchased by investors — took the largest percentage of the offering since 2022.
The same pattern was seen at Wednesday’s auction of $70bn of five-year notes, where dealers purchased the most since 2024. An auction of seven-year notes on Thursday was moderately better, but still weak by historical standards.
Additional reporting by George Steer, Harriet Clarfelt and Michelle Chan in New York