Mike Dolan: The US Treasury's seismograph is twitching after the Iran oil shock.

The Iran oil crisis has thrown rate forecasts into disarray and caused turbulence in the U.S. Treasury market - pushing?volatility up to its highest level in almost a year, and forcing sales that are taking a heavy toll on liquidity. The danger is that these tremors will spread.

The sheer size of the U.S. Treasury market is one of its main attractions. The $30 trillion market is large enough for the biggest buyers and sellers in the world to trade in and out without affecting?the price. This is a rare feature in any asset markets.

This is important to sovereign wealth funds and foreign reserve managers who are looking for a safe global asset that's not domestic to store their country savings. They want something they can easily and quickly cash out in times of national emergency.

Many people value liquidity, market size, and 24-hour trading as much as they do the return. The dollar's status as a reserve currency has allowed Washington to increase its debt without causing any market disruption, thanks to the price-insensitive demand. Size and liquidity attracts other participants, including hedge funds that profit from highly leveraged positions arbitraging small price anomalies between the cash and futures market. They increase market liquidity by doing this.

Many financial watchdogs are concerned about the growth of this so-called basis trading to more than a trillion dollars, mainly because it relies on liquid and smooth trading conditions.

This could cause a ripple effect that would be seismic in nature, affecting a market which is the bedrock of global finance.

STRESS BUILDERS

Then came the Iran attacks, and the oil spike. There was more than just a slight tremor in the seismograph. Treasuries were shook by the sudden erasure of expectations for Fed easing in 2026.

The implied volatility of the Treasury Market - the MOVE three-month index - has rocketed up to its highest level since May last year. This surge is alarming, as it's the largest monthly increase in the volatility index since early 2009 - shortly after the global banking crisis.

There are more disturbing details.

Morgan Stanley, a Wall Street bank, pointed out on Wednesday that the liquidity of short-dated Treasury bonds had markedly deteriorated amid global volatility and the dramatic change in rate expectations caused by the Iran conflict.

The bank found that the spreads on two-year Treasury bills - the amount intermediaries are charged for absorbing any uncertainty in the transactions - had increased by almost 30% or 0.15 basis points between February and March.

Trading volumes increased, and the weekly activity of "on-the run" Treasuries or new issues for two years was at its highest level since the tariff shock in April last year.

They believe that the peculiar combination of spread widening, high volumes and stressed sales suggests stress selling.

Morgan Stanley concluded that "Wider spreads between bid and ask would tend to discourage trading, but the fact that volume has increased regardless of this suggests that many trades were made out of necessity rather than desire."

FORCED SELLERS

Fed data for Treasuries in custody held by foreign officials such as central banks showed that there had been a'stressed selling?of sorts.

This is a drop of around $75 billion over the last four weeks. That's about $60 billion worth of active selling. It may be due to Middle Eastern holdings.

The poor reception of the two-year notes auctioned on Monday shows that the anxiety is still lingering in the market. It also raises the question as to whether this volatility is now impacting demand more widely.

The repo market has at least remained stable, despite wider turmoil.

Many fear that erratic policymaking by Washington, and the resulting uncertainty and market pressure could cause a financial system accident.

As officials worried about global financial stability earlier this month, repeated policy shocks and twists could cause many of the'more fragile' parts of the financial system to crack.

The treasury market is a very important area to monitor.

The opinions expressed are those of Mike Dolan a columnist at. This column is great! Open Interest (ROI) is your new essential source of global financial commentary. Follow ROI on LinkedIn and X. Listen to the Morning Bid podcast daily on Apple, Spotify or the app. Subscribe to the Morning Bid podcast and hear journalists discussing the latest news in finance and markets seven days a weeks.

(source: Reuters)