Rising Treasury market illiquidity could pose financial market risk -BofA

FILE PHOTO: A trader works on the trading floor at the New York Stock Exchange (NYSE) in Manhattan, New York City
FILE PHOTO: A trader works on the trading floor at the New York Stock Exchange (NYSE) in Manhattan, New York City, U.S., August 9, 2021. REUTERS/Andrew Kelly/File Photo

November 1, 2021

By David Randall

NEW YORK (Reuters) – Rising illiquidity in the $14.8 trillion U.S. Treasuries market could spill over into other financial markets as hedge funds reduce their capacity to take on risk, Bank of America warned in a report on Monday.

Leveraged hedge funds in particular have likely suffered large losses from the rapid increase in short-term Treasury yields, the report added.

“These moves have exposed still fragile U.S. Treasury market conditions,” Mark Cabana, head of U.S. Rates Strategy at Bank of America, wrote.

Rokos Capital Management and Alphadyne Asset Management have incurred losses as a result of wrong-way positions on government-bond yields, Bloomberg News reported https://www.bloomberg.com/news/articles/2021-10-29/a-wrong-way-bet-on-bond-yields-triggered-rokos-alphadyne-losses.

The warning comes as expectations that rapid gains in inflation may prompt the Federal Reserve to move more quickly to raise interest rates have helped flatten the yield curve at its swiftest pace since 2011. [L1N2RP2KS]

The Federal Open Market Committee is widely expected to announce Wednesday that it will begin tapering its $120 billion-per-month bond buying program.

While the move to end the support of the economy it put in place at the onset of the coronavirus pandemic has been well-telegraphed to investors, some investors worry that surging inflation will force the central bank to unwind its bond buying faster and eventually raise interest rates sooner than the Fed had earlier suggested.

(Reporting by David Randall; Editing by Mark Potter)