Dealer Capacity and US Treasury Market Functionality
Darrell Duffie1, Michael Fleming2, Frank Keane2, Claire Nelson3, Or Shachar2, Peter Van Tassel4
1Stanford University; 2Federal Reserve Bank of New York; 3Princeton University; 4Independent
We show a significant loss in US Treasury market functionality when intensive use of dealer balance sheets is needed to intermediate bond markets, as in March 2020. Although yield volatility explains most of the variation in Treasury market liquidity over time, when dealer balance sheet utilization reaches sufficiently high levels, liquidity is much worse than predicted by yield volatility alone. This is consistent with the existence of occasionally binding constraints on the intermediation capacity of bond markets.