Iran Oil Shock Sends US Treasury Market into Turmoil
The Iran oil shock has sent shockwaves through US Treasury markets, driving volatility to its highest level in nearly a year and forcing selling that's taking a serious toll on liquidity. According to Mike Dolan of Reuters, this development is particularly concerning because the US Treasury market is a crucial component of global finance, with a massive scale of $30 trillion.
The market's size and liquidity attract foreign reserve managers and sovereign wealth funds seeking a safe, non-domestic asset to bank their country's savings. These investors prioritize liquidity, market size, and round-the-clock trading over returns, which has allowed the US Treasury market to absorb large debt issuances without significant market disturbance.
However, this stability is now under threat due to the Iran conflict. The sudden wipeout of 2026 Fed easing expectations has sent implied volatility soaring to its highest level since last May, with a massive monthly rise in the three-month MOVE index. Morgan Stanley notes that liquidity in short-dated Treasury debt has deteriorated markedly amid global volatility and shifting rate expectations.
The bank's analysis suggests stressed selling, with wider bid-ask spreads and high volumes reflecting trades done out of necessity rather than desire. The Fed data on Treasuries held in custody by foreign official entities shows a drop of around $75 billion in the last four weeks, which may be related to Middle Eastern holdings.