The large reactions of long-term government bond yields to monetary policy shocks occur during periods of higher market liquidity, and there is very little reaction during periods of lower liquidity. This newly documented liquidity state-dependence persistently affects real yields, term premia as well as long-term mortgage rates. Balance sheet constraints on both hedge funds and dealers contribute to the liquidity state-dependence. Conditioning on market liquidity yields stronger state-dependence than simply conditioning on macroeconomic indicators. Our results underscore the importance of market functioning, and the financial health of key intermediaries that support it, for implementing stabilisation policies.