RDP 2025-07: Back to the Futures: Liquidity in Australian Bond Futures amid Market-moving Events since COVID-19 4. Review of Liquidity in Periods of Interest

4.1 March 2020: the onset of COVID-19 and introduction of the RBA's yield target

In late February 2020, pandemic concerns were escalating sharply, with government bond yields and risky asset prices both falling. In March 2020, government bond yields began unexpectedly rising: increased volatility meant that investors needed to raise cash to reduce leverage, meet margin calls, and meet redemptions. Many investors chose to sell government bonds because they are liquid. AGS market makers initially absorbed sales, but their capacity to undertake further trades and to assist price discovery deteriorated as dealer intermediation capacity began to run up against internal and regulatory risk limits, contributing to further volatility and impaired function in both the AGS and AGS futures markets (Finlay, Seibold and Xiang 2020). As the deterioration in financial market function became more serious, the RBA responded by: releasing a statement on 16 March stating that the Bank stands ready to support the smooth functioning of the government bond market; then, on 19 March, announcing a package of policy measures following an out-of-cycle Board meeting, including the RBA's intention to purchase government bonds to address market dislocations, with purchases beginning the following day (for more information, see Finlay et al (2023)).

Focusing on the futures market, Figure 6 shows bid-ask spreads, best depth, turnover, and price impact for the 3-year and 10-year contracts from 9 to 27 March 2020. The period of 10 to 16 March coincided with the futures roll, during which the minimum price increment (and so the minimum possible bid-ask spread) was lower than usual for the 10-year contract. For bid-ask spreads and price impact, higher values imply worse liquidity; for best depth and turnover, lower values imply worse liquidity.

Using the month of November 2019 as a control for the non-roll period of the sample (being 9 March 2020 and 17 to 27 March 2020), and 10 to 16 December 2019 as a control for the roll period of the sample (10 to 16 March 2020), we find that average bid-ask spreads rose modestly. For the non-roll period, they rose from 0.51 to 0.54 basis points for the 3-year contract and from 0.51 to 0.53 basis points for the 10-year contract. For the roll period, they rose from 0.52 to 0.56 basis points for the 3-year contract and from 0.27 to 0.29 basis points for the 10-year contract. The single period that stands out from a visual inspection was between 14.30 and 14.45 on Thursday, 19 March 2020, when bid-ask spreads for the 10-year contract widened to almost 2 basis points, that is, four times the minimum price increment. As noted in Finlay et al (2023), this corresponded to some initial confusion in the market around the nature of RBA bond purchases to restore market function, which were at first interpreted as being directed only to shorter maturity bonds around the 3-year tenor; once it became clear that the RBA would purchase bonds with up to 10 years to maturity, bid-ask spreads for the 10-year contract fell back to close to the minimum increment.

The tumult of March 2020 for the AGS futures market was more evident in other liquidity metrics. For the 3-year contract, average market depth fell from 1,000 to 370 contracts in the roll period and from 2,040 to 680 contracts in the non-roll period; average price impact rose by 67 per cent in the roll period and by 113 per cent in the non-roll period. Conversely average turnover increased, from 710 to 1,030 contracts per 5-minute interval in the roll period and from 970 to 1,020 contracts per 5-minute interval in the non-roll period. For the 10-year contract, average market depth fell from 270 to 110 contracts in the roll period and from 1,330 to 210 contracts in the non-roll period; average price impact rose by 56 per cent in the roll period and by 348 per cent in the non-roll period; while again turnover increased, from 770 to 1,190 contracts per 5-minute interval in the roll period and from 980 to 1,110 contracts per 5-minute interval in the non-roll period.^[11]

Taking as a given that March 2020 was a particularly stressed and illiquid period, a few points stand out:

• Apart from a truly acute period of stress between 14.30 to 14.45 on 19 March 2020, where market function for the 10-year contract deteriorated sharply, bid-ask spreads are not particularly responsive to stress and so do not appear to be the most useful gauge of liquidity conditions for AGS futures. That is, bid-ask spreads are usually at the minimum price increment, or very occasionally at two increments, largely irrespective of circumstances.

  This finding is in contrast to physical AGS, where bid-ask spreads are responsive to market conditions and widen meaningfully during periods of stress (see Finlay et al (2023)). Physical AGS are typically quoted in standard parcel sizes of $10 or $20 million depending on the tenor, whereas there is no equivalent standard number of futures contracts that dealers quote. This in turn reflects the types of entities that dominate market making in each market: in physical AGS, it is traditional dealers, which adhere to market conventions and trading platform guidelines regarding standard sizes; in futures, algorithmic market makers tend to dominate, and there is no standard parcel size to adhere to. Given that size is relatively fixed for physical AGS, dealers adjust to stress by widening bid-ask spreads; in futures the adjustment occurs via size (i.e. market depth).

• Market depth and price impact are responsive, and both deteriorated markedly during the acute phase of stress. By contrast, turnover was higher than usual during the period of stress, and for the 10-year contract was elevated during the acute phase of stress between 14.30 and 14.45 on 19 March 2020, at 9,880 contracts over that 15-minute period (whereas average turnover between 9 and 27 March 2020, excluding the open and close when turnover can sometimes be very high, was 2,620 per 15-minute period).

To sum up, it is almost always possible to trade some number of AGS futures contracts without having to cross a large bid-ask spread and without overly moving the price. During stress episodes, that number of contracts can fall considerably, but that does not necessarily stop investors from trading (albeit incurring higher transaction costs). These dynamics suggest that during stress, market participants have low conviction around the current price (hence low depth), and adjust their views quickly as buy/sell flows come in (hence high price impact).

4.2 October and November 2021: the end of the yield target

In late 2021, domestic activity and inflation showed signs of picking up, and markets started to revise their previously held view of ongoing subdued economic activity. This saw market participants begin to view the RBA's yield target – around 10 basis points for the 3-year AGS – as inconsistent with the revised outlook, and the target came under increasing pressure as the yield on the 3-year AGS rose. This pressure increased on 27 October 2021, when stronger-than-expected September quarter CPI data was released, and the pressure rose further in the days following when, counter to some market participants’ expectations, the RBA did not enter the market to purchase bonds in support of the target. The target was officially discontinued by the Reserve Bank Board on 2 November 2021.

Considering the week to 2 November 2021, and taking the final week of September 2021 as a control, average bid-ask spreads for the 3-year contract rose modestly, from 0.50 to 0.57 basis points; average turnover also rose, from 870 to 1,450 contracts per 5-minute interval; average depth fell by 90 per cent, from 2,820 to 280 contracts; and average price impact rose by 395 per cent (see Figure 7). Similarly, for the 10-year contract, average bid-ask spreads rose from 0.50 to 0.55 basis points; average turnover fell from 1,540 to 1,040 contracts per 5-minute interval; average depth fell around 90 per cent, from 1,690 to 190 contracts; and average price impact rose by 429 per cent.^[12]

Similar to the experience of March 2020, bid-ask spreads were affected by the period of market stress, but less so than other measures of liquidity, while depth and price impact saw very large effects, particularly in the days following 27 October as it became increasingly clear that the RBA was not going to intervene. Turnover was mixed, being a little higher on average for the 3-year contract and a little lower on average for the 10-year over the period considered. Again, the results suggest that even during acute stress it was possible to trade a small number of contracts without having to cross a large bid-ask spread, but that moderately to larger-sized trades move prices, thereby incurring significant transaction costs.

Liquidity conditions recovered a little over 2022 but remained materially poorer than had been the case prior to the end of the yield target (see Figures 3 and 4). For the 3-year contract excluding roll periods and the period of higher minimum price increments starting from October 2022, bid-ask spreads averaged 0.54 basis points over 2022, retracing half the widening seen at the end of the yield target, average depth increased just 10 per cent to 310 contracts, price impact fell around 10 per cent, and average turnover per 5-minute increment halved to 700 contracts, all relative to the end of the yield target period. For the 10-year contract, again excluding roll periods, bid-ask spreads retraced a little more than half their widening to average 0.52 basis points over 2022, depth doubled to 410 contracts, price impact fell 36 per cent, and turnover fell 20 per cent to 800 contracts.

Evidence suggests that international factors played a part in the persistence of poor liquidity in the AGS futures market through 2022, following the sharp deterioration in liquidity conditions caused by the end of the yield target. For example, liquidity conditions in the US Treasury market also deteriorated materially over late 2021 and through 2022, and remained worse than usual for a prolonged period (Fleming and Nelson 2022; Fleming 2024). It is very unlikely that events in Australia would impact US Treasury market liquidity; rather, a common global factor is likely to have contributed, namely heightened economic and policy uncertainty as inflation and interest rates rose globally over 2022, which caused worse liquidity in government bond markets around the world, including Australia.

4.3 January 2021: a particularly calm period in markets

In juxtaposition to March 2020 and November 2021, January 2021 was a particularly calm period in markets when the outlook for monetary policy appeared relatively certain: low rates for a prolonged period. The 3-year yield target was seen as credible, and the RBA had not had to conduct any purchases to support the target for some time.

Given this backdrop, we see essentially the opposite market dynamics to March 2020 and November 2021: bid-ask spreads were again largely stable at the minimum increment of 0.5 basis points, while turnover was in line with or lower than the control period, again taken as November 2019 (470 contracts on average per 5-minute window for the 3-year, versus 970 in the control period; and 1,060 contracts on average per 5-minute window for the 10-year, versus 980 in the control period). Conversely, market depth was higher than in November 2019 (19,120 contracts on average for the 3-year, versus 2,040 in the control period; and 1,770 contracts on average for the 10-year, versus 1,330 in the control period) and average price impact was lower (91 per cent lower than in the control period for the 3-year, and 27 per cent lower for the 10-year).^[13]

The results for the 3-year contract in particular stand out – depth is almost 10 times higher than in the control period, average price impact is over 10 times lower, but turnover is also lower. These results accord with the messages heard in market outreach at the time, which suggested that market participants were very confident that 3-year yields would be stable at their current level, hence a willingness to offer to transact large volumes at the current price, and minimal price impact from trades, but relatively little actual trading.

4.4 March, May and October 2021: changes to the RBA's securities lending fees

The RBA adjusted the fee it charged to lend out the yield target bond – the April 2024 AGS as at the time of the adjustments – to market participations on three occasions: at around midday on 9 March 2021 when it was raised from 25 to 100 basis points in an effort to discourage short-selling of the bond and so bring the bond's yield more into line with the target (largely successfully); at around midday on 7 May 2021 when the fee was lowered from 100 to 25 basis points given no current pressure on the yield target; and at 16.30 on 19 October 2021 when it was again raised from 25 to 100 basis points in an effort to defend the yield target (initially successfully, but only for a short period).

A higher fee to borrow a bond might be expected to reduce market liquidity in that bond (since market makers would find it more expensive to make a market, which often involves borrowing bonds), and a lower fee might have the opposite effect. But this does not appear to have been the case in the futures market, or at least any initial impact was relatively small.^[14] Considering the period from 30 minutes to 2½ hours after a fee change, versus the period from 2½ hours to 30 minutes before the change, the various metrics show no statistically significant changes in average liquidity.

4.5 April 2025: announcements of tariff changes by the United States and others

On the afternoon of 2 April 2025 Eastern Time in the United States (‘Liberation Day’, which was the morning of 3 April 2025 Sydney time), US President Trump announced baseline tariffs of 10 per cent on almost all goods imported into the United States, and additional tariffs on imports from countries that had a goods trade surplus with the United States. These tariffs were much larger than most market participants had been expecting, and over the following days resulted in significant falls in US equity prices, higher US Treasury yields, some strains in US Treasury markets, and a depreciation of the US dollar (see Perli (2025) for a discussion of the impact of the tariff announcements on the US Treasury market). These effects spilled over to other markets, including in Australia.

Similar to the United States, liquidity in the Australian government bond market deteriorated, with strains peaking around 9 April (Jacobs 2025). Liquidity in AGS futures deteriorated too, though this was somewhat less pronounced than for AGS themselves. As shown in Figure 8, bid-ask spreads for the 3-year futures contract were modestly higher (averaging 1.04 basis points on 9 April, versus 1.01 over the 5 days to 31 March), while depth fell materially (from an average of 4,460 contracts over the 5 days to 31 March, to 640 contracts on 9 April) and price impact rose to 2.3 times its end-March level. Turnover on 9 April was over twice its end-March average. Similar dynamics were observed in the 10-year futures (bid-ask spreads not much changed; depth falling by almost 90 per cent; price impact increasing by a factor of 3; and turnover almost doubling). As with other stress episodes, bid-ask spreads were only modestly affected, depth and price impact deteriorated meaningfully, and turnover rose.

Footnotes

Note that a t-test of the null hypothesis that the control period sample and March 2020 sample have the same mean is rejected for all statistics mentioned above. That is, differences between the control period and March 2020 are statistically significant. Expanding the control period to cover the four months to mid-February 2020 delivers very similar results. For comparison, the full sample medians for the 3-year contract are: bid-ask (excluding roll periods and the period of 1 basis point minimum price increments) of 0.51 basis points, depth of 1,790 contracts, and turnover of 280 contracts; the increase in price impact relative to the median is 41 per cent. For the 10-year contract, the full sample medians are: bid-ask (excluding roll periods) of 0.50 basis points, depth of 670 contracts, and turnover of 420 contracts; the increase in price impact relative to the median is 239 per cent. For reference, the full sample median for the daily absolute price change is 1 basis point for both the 3-year contract and the 10-year contract. [11]

As above, all changes between periods are statistically significant. For comparison, the full sample medians for the 3-year contract are: bid-ask (excluding roll periods and the period of 1 basis point minimum price increments) of 0.51 basis points, depth of 1,790 contracts, and turnover of 280 contracts; the increase in price impact relative to the median is 191 per cent. For the 10-year contract the full sample medians are: bid-ask (excluding roll periods) of 0.50 basis points, depth of 670 contracts, and turnover of 420 contracts; the increase in price impact relative to the median is 207 per cent. [12]

As above, all changes between periods are statistically significant. Expanding the control group to cover the four months to mid-February 2020 does not change the results. For comparison and as noted previously, the full sample medians for the 3-year contract are: bid-ask (excluding roll periods and the period of 1 basis point minimum price increments) of 0.51 basis points, depth of 1,790 contracts, and turnover of 280 contracts; the decrease in price impact relative to the median is 94 per cent. For the 10-year contract, the full sample medians are: bid-ask (excluding roll periods) of 0.50 basis points, depth of 670 contracts, and turnover of 420 contracts; the decrease in price impact relative to the median is 45 per cent. [13]

Other considerations beyond the strict cost to borrow the bond that may have influenced outcomes include any signals that the fee change may have sent to the market, including that the RBA was committed to the yield target policy, or conversely that the policy was coming under increasing market pressure. [14]