August 10, 2021
Nearly a year and a half has passed since the COVID-19 pandemic first swept the globe. While the markets have calmed and the global economy—despite ongoing public health challenges—continues to emerge from a short but severe recession, it’s a good time to reflect on the pandemic’s impact on the markets, particularly fixed income.
Fixed income investors responded to the economic shock of the pandemic by rapidly selling assets to bolster their liquidity positions in a dash for cash. This broad divestment overwhelmed traditional channels, leading to a liquidity crunch and price dislocations across multiple fixed income sectors. Even the traditional safe haven of the U.S. Treasury markets experienced notable pressures. The volatility quickly spread to other fixed income sectors across the U.S. and Europe, including commercial paper, corporate bonds, variable-rate demand notes, mortgage-backed securities, and municipal bonds.
Several factors influenced the strain on the fixed income markets. The general size and complexity of global fixed income markets, the magnitude of selling pressure in certain asset classes, dealers’ willingness or ability to warehouse assets, and the evolution of fixed income market structure over time all contributed to the breakdown in dealer intermediation. Swift and comprehensive intervention by central banks and policymakers helped restore normal market functioning, with central banks acting as a key liquidity provider and market-maker of last resort.
As our research points out, to reduce the likelihood of future intervention by central banks, any policy response should consider ways to enhance the market structure for U.S. Treasury securities, such as ensuring that policymakers have the data necessary to properly surveil the U.S. Treasury market, facilitate market functioning under stress, and inform future regulatory actions. Further, reforms that would foster continuous market-making and improved transparency should be considered. The market for U.S. Treasury securities is a vital part of our global fixed income markets and must be resilient during times of market stress.
For an in-depth analysis of the fixed income markets during the height of the pandemic-related market volatility and our recommendations for a path forward, check out our paper:
The dash for cash: Observations on the fixed income market ecosystem during COVID-19