Treasury liquidity and the demand for cash - There can be a run on the safe asset market

Investors generally have a strong view that Treasuries are a global safe asset. It is a true that they are the place to go if you need safety from risk. Demand will increase when the economy slows or there is a decline in risk asset expectations.  Some will say prices rise for Treasuries during a crisis because there is a shortage of the safe asset. Having a safe asset is important, but Treasuries are not cash.

At some level of uncertainty, not just risk, investors will want cash, the ultimate safe asset. At high uncertainty there is no demand for an asset with duration risk, no desire to hold an asset that will have a charge for liquidity through the bid-ask spread, for some settlement uncertainty, or has pricing uncertainty based on short-term flows. As uncertainty rises, Treasuries become just another risky asset. Perhaps less risky than other assets but not a safe asset. While this is not the conclusion of the Fed, it is a reality when reviewing the deep dive on Treasury liquidity by the NY Fed as presented by Lorie Logan in her speech "Treasury Market Liquidity and Early Lessons from the Pandemic Shock", Remarks at Brookings-Chicago Booth Task Force on Financial Stability (TFFS) meeting, panel on market liquidity (delivered via videoconference).  

When the pandemic policies hit in March and there was maximum uncertainty on the course of the US and global economies, there was not a flight to Treasuries as the safe asset. There was an unwinding of any risk and a move to cash, a run on the safe asset. Hedge funds sold levered positions, foreign central banks raised cash, and mutual funds sold risky assets to prepare for outflows. When there is an investor run on risk and a desire for cash, the safe asset will be subject to distortions and become unsafe. None of this should have been surprising when the herd has a massive change in expectations. 

The Fed had only one course of action; become the buyer of last resort. However, Fed purchases of Treasuries have continued, and the crisis manager is now an integral part of the safe asset market and not just a lender of last resort. 

The real question is what would the Treasury market look like today if the Fed was a less significant player? The technocrats are now running the market, so hope that they have the vision to deal with the known unknowns and unknown unknowns that we can face with the safe asset. These choices do not belong to the private market.