Five forces reshaping fixed income markets
However, the degree of this synchronicity is not constant. Our analysts find that it varies across geographies and points on the yield curve. Specifically, domestic factors can either soften or exacerbate the response of a specific bond market to gyrations in US Treasuries. Levels of sensitivity also vary over time, changing as macro conditions evolve.
But one thing is clear: any tremor in US Treasuries is likely to be felt far and wide.
For regulators, watching over these rapidly changing fixed income markets will not be easy. Our analysts see something of a “trilemma”: authorities can try to create systems that function well, are low-risk and are free of moral hazard. But they probably cannot achieve all three aims at once.
The huge extra supply of US Treasuries set to wash over the market is likely to create new strains on intermediaries such as dealers. And vulnerabilities may not be obvious until they are exposed by events. Recent episodes such as the 2019 blow-up in repos, a market for interbank lending, and the COVID-induced “dash for cash” in early 2020 suggest that markets are increasingly prone to instability.
New regulatory constraints could exacerbate frictions. Take the central-clearing mandate from the Securities and Exchange Commission, due to be phased in from 2025. This looks set to relieve some strains on intermediaries but will likely introduce new ones in their place, which could add new costs as the size of the Treasury market increases. Each new requirement like this has the potential to add complexity and subtract flexibility, raising the chances of severe dislocations. Those, in turn, would require interventions from policymakers to restore stability – which could remove incentives for market participants to guard against risk.
The result: fixed-income markets are likely to become more fragile, subject to more regular bouts of illiquidity and heightened volatility.
