Treasury liquidity -There is an issue of illiquidity risk

The Federal Reserve Bank of New York has started a multi-part series on liquidity in the Treasury market. The issue of liquidity has been a growing concern market participants, but the evidence presented by the Fed on this issue is exactly not clear. The bid-ask spreads for Treasuries has remained stable. Depth in the market has declined from highs. Trade size has declined which seems to suggest that the market is adjusting to less liquidity. Yield curve errors or dislocations against a smooth Treasury curve  have not increased which suggests that there is no shortage of liquidity for off the run Treasuries. Refcorp bonds that are substitutes for Treasuries have higher spreads but are stable.

The key statistic may be the market impact of trades. This series has shown more volatility. This may represent our best measure of liquidity risk, or to be put more clearly, illiquidity risk. Showing that there is market liquidity is not the same as not having liquidity at specific times. This is a classic black swan problem. Counting white swans of past liquidity does not tell us whether we will have a black swan liquidity event. The fact that market impact has become more volatility especially in the 10-year sector suggests there is more risk of any trade having an impact.

The Fed would like to put liquidity concerns to rest. Their evidence sheds good light on the problem but does not solve the perception of illiquidity risk.