Iran Conflict Sparks Liquidity Crunch Across Major Financial Hubs

The escalating Iran war triggers a global liquidity crunch, widening bid-ask spreads and forcing market makers to retreat from US Treasuries, gold, and bonds.

By: AXL Media

Published: Mar 30, 2026, 3:38 AM EDT

Source: Reuters

Widening Spreads and the Retreat of Market Makers

The war in Iran has sent shockwaves through the world’s most liquid markets, creating a environment where trading is becoming both more difficult and significantly more expensive. In the U.S. Treasury market, the bid-ask spread on two-year notes—a primary barometer of market health—has surged by approximately 27% in March compared to the previous month. This widening indicates that dealers are demanding a much higher premium to facilitate trades, fearing that rapid price swings could turn their inventories unprofitable in seconds. Investors report that executing large orders now requires extreme patience, as market makers insist on "slicing" trades into smaller fragments to avoid being caught in a volatility trap.

Severe Diminishment in Futures and Bond Markets

The impact has been particularly acute in Europe, where the futures market for short-term interest rates saw liquidity drop to just 10% of its normal levels during peak volatility. Analysts at Morgan Stanley have compared the current market paralysis to the early days of the 2020 COVID pandemic, noting that the depth of the market has evaporated as traders struggle to price in central bank responses to war-induced inflation. Regulators in Europe warned on Friday that the ongoing tensions are creating a dangerous feedback loop: higher energy prices fuel inflationary fears, which in turn drive up bond yields and drain the very liquidity needed to keep the market functioning orderly.

The Role of Hedge Funds and Forced Unwinds

A significant driver of the recent bond market turmoil has been the rapid unwinding of positions by hedge funds. In the UK and Eurozone, these funds now account for over 50% of government bond trading volume. Many had entered the month with similar bets—namely that central banks would cut rates—which became disastrously loss-making as the war broke out. The simultaneous rush to exit these "crowded" trades forced dealers to widen spreads even further to protect their bottom lines. This mass de-risking has exacerbated price swings, turning what were intended to be hedge fund "carry trades" into a primary source of market instability.