Yellen, speaking to the Securities Industry and Financial Markets Association’s (SIFMA) annual meeting in New York, acknowledged that liquidity in the vast Treasuries market has diminished, raising costs, but this and other parts of the U.S. financial system have not been a source of financial instability.
VOLATILITY & LIQUIDITY
“It’s not unexpected that in a world of increased volatility that liquidity should diminish somewhat or the cost of transacting might rise a little, but my assessment is that markets are well functioning, trading volumes are large, traders are not having difficulty executing trades,” Yellen said.
Yellen said that her department was looking carefully at steps to improve Treasury market functioning, noting that the capacity of broker-dealers to intermediate in the market has not grown in line with the market’s size in recent years.
“So we’re looking at the number of ways to improve resilience, make sure that intermediation is available, enhance oversight of trading venues, increase the transparency and have better data on markets,” Yellen said, without detailing specific steps.
An index of near-term volatility in the Treasury market from ICE/Bank of America Merrill Lynch is near the highest level since the spring of 2020 when market dislocations during the early days of the COVID-19 pandemic forced the Federal Reserve to step in to restore order.
Yellen in prepared remarks cited this and other episodes of stress as underscoring the need to enhancing resilience.
“Treasury is working with financial regulators to advance reforms that improve the Treasury market’s ability to absorb shocks and disruptions, rather than to amplify them,” Yellen said.
MONEY MARKETS, BOND FUNDS
Higher market volatility also could expose vulnerabilities in non-bank financial intermediation, Yellen said.
She added that Treasury and financial regulators are working to better monitor leverage in private funds and to “develop policies to reduce the first-mover advantage that could lead to investor runs in money market funds and open-end bond funds.”
Yellen cited stresses in money market funds during the 2008 financial crisis and again in March 2020 as the reason for the Securities and Exchange Commission’s new proposed rules to improve resilience and transparency in the $5 trillion money market sector.
“Open-end bond funds have a similar issue of promising daily liquidity while holding assets where, when there are fire sales, there can be stresses when it comes to liquidating the underlying assets,” Yellen said.
She also said that Treasury was beginning to monitor hedge funds more closely to gain insight into their leverage, concentrated positions and role in the turmoil of March 2020.
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