Black swans, pink flamingos, and Treasury liquidity

 

Black swans are large unknown unknown events, but pink flamingos are known knowns. While investor attention is often on black swans, we cannot do much about them other than diversify and hope for the best. However, pink flamingo events are right in front of us, and we should be able to do something about them. 

Treasury liquidity or the decline in liquidity is a current problem that is well documented and will have a strong impact on financial market, yet there is little that has been done about it. It is a pink flamingo, a known known.

We know Treasury liquidity is lower based on the top of the book orders. We know that Treasury dealers are now less important in the process of Treasury auctions. We know that the financing for Treasury dealers has been an ongoing issue and has required extra repo funding, and we know that bank Treasury dealers have committed less capital to dealer operation given the restrictions from the supplemental leverage ratios, yet there is no real action other than to discuss how the structure of the Treasury markets are changing. 

This is a large pink flamingo which we have created and not addressed. It may not be an issue today, but with bond volatility high and the Fed selling more Treasuries through QT it is just a matter of time before we have a problem.