What’s behind the U.S. Treasury market’s roller coaster ride?

Recent abrupt shifts in the multi‑trillion‑dollar U.S. Treasury market have garnered significant attention. In this Q&A, we explore the factors driving the moves, the potential for policy responses, and the key factors to watch out for next.

What has been going on in U.S. Treasury markets?

U.S. Treasuries have been on a roller coaster ride. The initial rally following the April 2 tariff announcement gave way to a dramatic sell‑off in a liquidity‑strained market that prompted some calls for policy action to help alleviate the pressures. Although the April 9 90‑day pause in additional tariffs on countries has helped restore some calm to the world’s biggest bond market, it’s important to understand the factors behind the sell‑off and how developments could evolve from here.

In a nutshell, the combination of poor liquidity and rapidly shifting narratives driving sentiment caused outsized yield moves in U.S. Treasuries. Some of these narratives involved hedge funds unwinding trades designed to profit from small price differences between cash Treasuries and futures contracts, as well as foreign holders of Treasuries selling their positions.

But the real reason that Treasury yields have been so volatile is that the Treasury Department issued approximately USD 2.3 trillion in new debt annually from 2020 through 2024. At the same time, regulators have not allowed bond dealers to expand their balance sheet market‑making capacity. This has created a situation that is the rough equivalent of funneling the traffic on a busy four‑lane highway into only one lane.

For now, it appears that the worst of the situation may have passed, but volatility in Treasury markets is here to stay. Taking a step back, it’s important to understand the interconnection between the U.S. trade deficit and the financial account surplus. For the past four to five decades, the global economic order was structured so that the U.S. imported cheap goods, meaning that dollars were being exported globally. These dollars served as the basis for the majority of trade transactions, global central bank reserves, and financial transactions globally, which underpinned the U.S. dollar’s reserve currency status. This was further supported by the rule of law and the sheer depth and breadth of U.S. financial markets. These dollars were then recycled back into the U.S. in the form of a financial account surplus.

Consequently, the U.S. announcement about curbing its current account deficit has the super‑secular potential to partially unwind the financial surplus that the U.S. has benefited from. We are monitoring this closely as it could have broad long‑term implications for all U.S. assets. The U.S. Treasury market, where almost a third is held by investors outside the U.S., could be meaningfully affected over the secular horizon.

Could heightened volatility prompt a policy response?

The Federal Reserve can make tweaks to help market functioning, but the central bank is unlikely to start buying Treasuries through quantitative easing—as it did in March 2020—unless there is an outright breakdown in market structure. These relatively minor adjustments are likely to include changes to the dynamics of the standing repo facility (SRF) to widen timing or collateral acceptance to ease funding issues.

Keep in mind that the Fed also needs to maintain its independence from politics in dealing with the ramifications of the Trump administration’s tariffs.

What is the condition of the plumbing that underpins bank funding?

Bank funding pressures are building amid the market volatility, but we are not seeing signs of stress along the lines of those that appeared at the onset of the pandemic in early 2020. Secured funding rates (SOFR and tri‑party repo) have moderated from their quarter‑end levels and remain only slightly elevated relative to longer history. Part of the increase is due to the ever‑growing financing needs of primary dealers, whose holdings account for a growing percentage of all bank reserve balances.

On the positive side, sponsored repo has grown significantly. The Fed’s SRF remains unutilized, although shortened hours of operation and the lack of small banks on the approved counterparty list can also be limiting factors. Bank commercial paper spreads have been well behaved, staying much lower than their levels following the regional banking crisis in 2023. Similarly, advances from the Federal Home Loan Banks (FHLB) have increased only marginally.

Looking across banks by size, the large banks have allowed liquidity to run at the lower end of their historic range. More positively, small banks have shored up liquidity ahead of tax season, when they tend to see more volatility in cash balances.

What indicators are you monitoring for signs of further liquidity deterioration or bank funding stress?

Treasury auctions are critical to watch for signs of faltering demand, and we agree that problems selling new issues—even with meaningful yield concession—would be a negative signal.

Looking beyond the Treasury market, credit markets have been relatively orderly as of early April, although new corporate bond issuance has almost ground to a halt. We’re closely watching data on outflows from credit exchange‑traded funds (ETFs) and institutional credit funds. A rush to exit these products could drive a liquidity freeze in credit markets that could then lead to even more selling pressure on Treasuries to raise cash.

In the bank funding markets, we’re monitoring primary dealer holdings as a percentage of reserves and the use of backstop lending facilities like the SRF. Sudden upticks in FHLB funding demands would also indicate elevated stress levels in bank funding.