BIS study: high debt worsens US Treasury market liquidity, and non-banks widen the range of outcomes
Victoria Shinder2 min readA BIS Bulletin published on 29 September by Mathias Drehmann and Sonya Zhu examines how government debt levels and the growing role of non-bank financial institutions affect the functioning of government bond markets. For lack of comparable data elsewhere, the analysis focuses on the US Treasury market. As with all BIS Bulletins, the views are the authors' own, not the BIS's.
The measure. The authors use a US Treasury market conditions index, the first principal component of variables including the MOVE volatility index, a government securities liquidity index, quoted spreads and time to quote, the on-the-run premium, the overnight index swap spread and the Treasury futures basis. Higher values mean worse conditions. The index recorded a six-standard-deviation shock in March 2020, and roughly two-standard-deviation shocks in November 2008, February 2016 and October 2022.
What they find. Between July 2004 and May 2024 the average index value was 0.23 when the government debt-to-GDP ratio was in its bottom third and 0.4 when it was in its top third, and conditions were also worse on average when non-banks held a larger share of government debt. The non-bank footprint is measured by holdings of money market funds, investment funds, pension funds and insurers. To test prediction rather than correlation, the authors forecast the index three months ahead with a random forest model trained on rolling windows and 44 other explanatory variables. Two results:
- High debt shifts the whole distribution towards worse liquidity. The probability of exceeding any level of the index in three months is always higher when debt is in its top third.
- A large non-bank footprint widens the distribution. It raises the risk of dysfunction and also makes very favourable liquidity more likely, consistent with non-banks supplying liquidity in good times and amplifying shocks in bad ones.
Why. The bulletin points to liquidity mismatches in money market and open-ended funds, which can produce fire sales as in the March 2020 dash for cash, and to risk-management strategies of insurers and pension funds, such as derivatives use, that can create sudden liquidity needs.
What it means
The finding is about the shape of risk, not its average: a Treasury market with more debt and more non-bank holders is not simply worse, it is more two-sided. For policymakers that argues for tools aimed at the tail, such as central clearing and backstops, rather than for judging market health by how calm it looks in good times.