Josh Younger Explains Why the Bond Market Has Been So Volatile

Episode Summary

Executive Summary: The episode examines why U.S. Treasury markets have become unusually volatile and less liquid, especially during sharp rate repricing and in the shadow of March 2020’s dysfunction. Josh Younger explains that low market depth, balance-sheet constraints, repo/basis-trade dynamics, and pro-cyclical margining can impair intermediation even in the world’s most important market. He argues current stress is serious but far from a 2020-style breakdown.

Main Topics: Treasury market volatility and liquidity stress (Priority: 5/5): The hosts frame recent large moves in Treasury yields as unusually volatile for a supposedly safe, liquid asset. Younger distinguishes between fundamental repricing and true market dysfunction. What illiquidity means in Treasuries (Priority: 5/5): Younger defines liquidity as the ability to move size into cash at low cost and explains market depth, bid-ask spreads, and the role of dealers in absorbing risk. March 2020 dysfunction and the dash for cash (Priority: 5/5): The discussion revisits the pandemic shock, when Treasury depth vanished, spreads widened sharply, and the market stopped functioning as a reliable cash-equivalent asset. Balance-sheet constraints and dealer intermediation (Priority: 4/5): The guests discuss how leverage rules like the SLR constrain banks’ willingness to warehouse Treasuries, especially when everyone wants cash and dealers must compete for scarce balance sheet. HFTs, hedge funds, and the fragility of non-bank intermediation (Priority: 4/5): High-frequency traders and levered hedge-fund basis trades absorbed much of the market-making role, but both models weaken during high volatility, removing liquidity when it is needed most. Policy responses: clearing, sponsored repo, and regulatory reform (Priority: 4/5): Younger evaluates central clearing, sponsored repo, temporary SLR relief, and cross-margining as partial fixes, while cautioning that no single change will fully solve the problem. Why current stress is concerning but not catastrophic (Priority: 4/5): The Fed may tolerate rising yields if financial conditions are tightening as intended; current market functioning is strained but still far better than in 2020.

Key Arguments: Recent Treasury moves can be partly explained by fundamental news, such as expectations of a 75 bps Fed hike, but low depth can magnify those moves beyond what fundamentals alone justify. Liquidity in Treasuries should be judged by whether large positions can be converted into cash quickly and cheaply; in stressed periods, that capacity breaks down. March 2020 was not merely illiquidity but market dysfunction: bid-ask spreads widened several-fold and price discovery itself became unreliable. Bank dealers are constrained by leverage and balance-sheet rules, making it hard to intermediate one-sided selling when many participants want cash at once. HFTs provide much of the on-screen liquidity in normal times, but they retreat when volatility spikes, so they cannot be relied on as a backstop in crises. Basis trades and repo-funded positions created a fragile non-bank intermediation layer that disappeared under stress, leaving banks unable to replace it at reasonable cost. Sponsored repo and central clearing can help net exposures and reduce regulatory balance-sheet usage, but their practical impact is limited and depends on market direction and positioning. The market does not need to be designed to survive a once-in-a-century pandemic shock, but it does need greater resilience to more routine volatility episodes. The Fed is less alarmed now because the market is still functioning and current yield increases are partly consistent with its tightening goals; it would intervene more forcefully only if functioning deteriorated materially.

Data Points: 10-year Treasury yield move: about 28 basis points in one day - Cited as a four-standard-deviation move after reports the Fed might hike 75 bps Statistical rarity: four standard deviations - Used to illustrate how unusual the 10-year Treasury move was Bitcoin comparison: 2.7 standard deviations - Bitcoin’s move in the same period was smaller than Treasuries’ by this measure Market depth in normal times: $150 million to $200 million - Average size available within three levels of the best price during New York trading Market depth in bad times: $5 million to $10 million - Depth level seen in severe stress, including March 2020 Current market depth: around $40 million to $50 million - Approximate average depth within three levels of best price at the time of the discussion March 2020 bid-ask spread: 3 to 5 times wider - Treasury bid-ask spreads widened dramatically during the pandemic selloff Treasury market size: about $23 trillion outstanding - Referenced as the scale of the Treasury market amid rising federal deficits Fed balance sheet behavior: bought half of net supply for the past two years - Younger says the Fed helped absorb Treasury supply through QE HFT share of on-screen depth: 70% to 80% - High-frequency traders were described as the majority of visible market depth before stress hit Temporary SLR relief: 1 year - The Fed temporarily excluded cash and Treasuries from the supplementary leverage ratio in 2020

Pivotal Quotes: "the most important market in the world" — Tracy Allaway / Josh Younger: Describing the U.S. Treasury market and why its functioning matters broadly "If risk is clearing, if you can get the trade done, you can do it at a relatively tight bid offer" — Josh Younger: Explaining why current Treasury conditions are strained but still functioning "we should not be creating or designing a treasury market that is specifically calibrated to survive a once a century pandemic liquidity squeeze" — Josh Younger: Arguing against overengineering reforms solely for 2020-style extremes

Implications: Listeners should expect Treasury volatility to persist as rates rise and balance-sheet limits bind. The bigger lesson is that market structure, not just fundamentals, can amplify shocks. Reform is likely to be incremental, not a full fix.