(Bloomberg) — The stark reversal of fortune for Treasury Inflation-Protected Securities this year is playing out in a much more automated trading landscape than when inflation was low, according to Tradeweb Markets Inc.
The past year’s surge in demand for inflation protection wrought changes in the market that should persist even if the Federal Reserve succeeds in restoring price stability, the firm argues in a blog post.
While TIPS liquidity “still notably lags” compared with nominal Treasuries, “significant investments in infrastructure by TIPS liquidity providers over the last several years” are making a measurable difference, Tradeweb says. The company operates a leading electronic trading platform for US government bonds.
In particular:
- In the request-for-quote (RFQ) trading protocol, dealer response times of under a second have increased to around 70% from around 50% in mid-2021, the approximate level since early 2020, “a clear sign of auto-quoting,” Tradeweb says
- On the customer side, there’s been an increase in auto-execution trades suggesting “that the market is getting comfortable enough with TIPS liquidity to ‘set it and forget it’ through automation”
- Percentage of tickets executed via Tradeweb’s automated-execution engine AiEX exceeds 20%, up from closer to 10% in 2020
- Number of trades by institutional clients on Tradeweb platform more than doubled over 2016-2021, “with notable growth happening this year”
- TIPS market growth is also driving liquidity improvements, Tradeweb says; issuance increased 29% between 2016 and 2021, and New York Fed’s primary dealer statistics show average daily volumes up 34% over the same period
At the same time, the broader Treasury market is experiencing liquidity erosion associated with Fed policy shifts, and TIPS are subject to some of the same dynamics.
TIPS — which pay interest at lower rates than regular Treasury securities on principal that’s indexed to the US Consumer Price Index, making holders indifferent to inflation — remain a much smaller market, equal to less than 8% of Treasury debt outstanding.
The return of inflation in the US last year — and its unexpected failure to abate — pulled money into the asset class. As a proxy, shares outstanding in the main exchange-traded fund for TIPS nearly doubled from April 2020 to January 2022.
At the same time, the Fed’s purchases of Treasuries from March 2020 to March 2022 increased its TIPS holdings by $256 billion, exceeding the $195 billion of net issuance over the same period.
The steep ramp-up in demand from two price-insensitive buyers — ETFs and the Fed — was a big change for the TIPS market, which wasn’t accustomed to a lot of passive investment, and volumes surged.
Now, with the Fed hiking rates to rein in price increases that have sent headline CPI to the highest levels since early 1980s, inflation expectations have begun to fade, and the iShares TIPS Bond ETF has shrunk by nearly 15%.
Meanwhile, the central bank ended its purchases of Treasuries in March, and the US government continues to increase the supply of TIPS while shrinking the sizes of its nominal coupon sales.
(Adds TIPS market dynamics during pandemic era following bullets.)
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