Dealer Balance Sheet Capacity and Market Liquidity during the 2013 Selloff in Fixed-Income Markets

Adrian, Tobias; Fleming, Michael J.; Goldberg, Jonathan; Lewis, Morgan; Natalucci, Fabio M.; Wu, Jason J.

Discussion Paper

Dealer Balance Sheet Capacity and Market Liquidity during the 2013 Selloff in Fixed-Income Markets

Abstract: Long-term interest rates hit record-low levels in 2012 but have since increased substantially. As discussed in an earlier post, the sharpest increase occurred between May 2 and July 5 of this year, with the ten-year Treasury yield rising from 1.63 percent to 2.74 percent. During the May-July episode, market liquidity also deteriorated. Some market participants have suggested that constraints on dealer balance sheet capacity impaired liquidity during the selloff, amplifying the magnitude and speed of the rise in interest rates and volatility. In this post, we review the evolution of Treasury market liquidity, evaluate whether dealer balance sheet capacity amplified the selloff, and examine what motivated dealer behavior during the episode.

Keywords: positions; liquidity; selloff; Dealers; fixed income;

JEL Classification: G1;G2;