Morgan Stanley finds that market volatility triggered by war has led to a decline in U.S. Treasury liquidity

MaticHoleFiller · 2026-04-12T07:44:47+00:00

Morgan Stanley's strategists' report points out that the U.S. Treasury market has experienced sell-offs due to market reactions to Federal Reserve rate hike expectations, especially with the two-year Treasury yield rising sharply. The decline in liquidity and widening bid-ask spreads indicate that most trades are forced, and increased market volatility has led to higher trading volumes, particularly against the backdrop of rising oil prices driven by conflicts in the Middle East.

MaticHoleFiller

2026-04-12 07:44:47

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Morgan Stanley’s interest rate strategist said that the decline in the U.S. Treasury market this month exhibits characteristics of forced selling of two-year Treasuries. Previously, traders abandoned bets on Federal Reserve rate cuts and instead began pricing in rate hikes, leading to a sharp rise in two-year Treasury yields.

The Morgan Stanley strategist team led by Eli Carter pointed out in a report on Wednesday that trading data from CME’s BrokerTec platform shows that since the U.S. strike on Iran on February 28, liquidity in the U.S. Treasury market has noticeably decreased, especially at the short end. They noted that, by contrast, longer-term instruments like the 10-year Treasury have remained relatively stable.

The report highlighted evidence including widening bid-ask spreads among trading institutions and, in this environment of higher trading costs (broader bid-ask spreads) that typically suppress trading, an increase in trading volume.

The strategists found that for the latest issuance of two-year Treasuries, the bid-ask spread has widened by about 27% since February.

Meanwhile, trading volume has risen to its highest level since April, when U.S. President Donald Trump’s so-called “Liberation Day” tariff announcement triggered a stock market sell-off, initially boosting demand for U.S. debt. But subsequently, as market volatility intensified and crowded trades were unwound, yields began to rise.

The strategists stated, “Wider bid-ask spreads usually suppress trading, yet volume continues to increase, indicating many trades are ‘forced’ rather than voluntary.”

The outbreak of Middle East conflict drove oil prices sharply higher, and as this could push up inflation through retail gasoline prices, market expectations for rate cuts were completely shattered.

Since the conflict began, the two-year U.S. Treasury yield has risen about 50 basis points to 3.87%. However, Morgan Stanley noted that their analysis shows this sell-off was further amplified by position unwinding and deteriorating liquidity.

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