The pressure that pushes the US Treasury to think about buying back bonds
1. What is happening in the Treasury market?
Treasury liquidity measures in September hit the worst levels since the market chaos at the start of the pandemic. The Bloomberg US Government Securities Liquidity Index – an indicator of yield deviations from a fair value model – remains near the highest levels since March 2020, when a flight to cash prompted the Fed to start buying stocks to stabilize the market. Treasury Secretary Janet Yellen expressed concern in mid-October, noting that brokers’ balance sheet capacity to engage in Treasury market-making had not increased alongside an increase in supply. aggregate of treasury bills. Outstanding Treasury debt has increased by about $7 trillion since the end of 2019, but major financial institutions have not been as willing to serve as market makers.
2. What is causing the problem?
A year of steep losses for bonds caused by rising inflation and interest rate hikes by the Fed led many large traditional participants, such as U.S. commercial banks, foreign governments and life insurers, to turn away from the debt market. Large financial institutions have not been as willing to serve as market makers, burdened by the so-called Supplemental Leverage Ratio, or SLR, which requires banks to set aside capital against such activity. In addition, the Federal Reserve has begun to reduce some of its holdings of Treasuries, a process known as quantitative tightening that many fear will worsen liquidity problems.
3. What is the Fed doing?
It is currently unloading its Treasuries from its balance sheet at a rate of $60 billion per month. As the biggest buyer of government debt, its decision to step back means dealers are going to have to absorb the additional supply that is returning to the market. This is a task that will become increasingly difficult as the Fed’s balance sheet reduction drags on.
4. What does the Treasury intend to do?
It decides whether it will buy back older securities and replace them with larger current issues of treasury bills or notes and bonds, depending on the government’s objective.
5. Has he done this before?
The Treasury last conducted buyback operations between March 2000 and April 2002 to allow the department to continue to sell new bonds to maintain market access at a time when the federal government was running a budget surplus and not didn’t need the money. Funds raised by selling new bonds were used to buy back old ones.
6. How would Treasury buybacks work?
That’s what he’s trying to figure out right now. In its quarterly survey released as part of the funding to be announced Nov. 2, it asked the 25 primary dealers that serve as its intermediary to the broader debt market for a detailed assessment of the merits and limitations of a buyback program. At this point, the crucial question for Wall Street strategists is whether the trades would be duration-neutral. This means that all government securities bought back by the Treasury would be replaced by debt of the same maturity in order to keep the weighted average maturity of outstanding debt – currently a record 74 months – practically unchanged.
7. How would this improve Treasury market liquidity?
Repurchase operations would provide an alternative buyer for less liquid and less desired out-of-run issues. The Treasury could retire old and cheap securities and offer dealers an outlet to improve their balance sheet management. Additionally, the signaling impact of a trade could help market functioning if conditions were to improve on announcements alone. For example, 20-year bonds, the segment of the market that appears to have the most to gain from a buyback program, rebounded after the survey’s release.
8. When could this happen?
It’s too early to tell. Bank of America strategists predict that the Treasury could launch its program in May 2023, although they acknowledged that the timetable could be accelerated in the event of “intense problems in the functioning of the Treasury market”. After all, the systems are already in place to conduct such operations. However, Credit Suisse strategist Jonathan Cohn sees the first quarter of 2023 as the earliest launch date, based on deteriorating liquidity and dealer balance sheet constraints.
9. Is there anything else that can be done to improve the functioning of the market?
For starters, the Fed could adjust the terms of its permanent repo facility — where banks can park their Treasuries overnight in exchange for cash — to make Treasuries more attractive to hold. The Securities and Exchange Commission is proposing to move more Treasury bill trading activity to existing clearinghouses — which sit between buyers and sellers and ultimately support transactions — in a bid to protect themselves against market crashes. Market participants are also hoping for other changes, such as the Fed exempting Treasuries from the additional leverage ratio, which would give banks more incentive to hold government debt, especially in low-volume environments. The Fed had waived Treasury and SLR bank reserves in March 2020 before letting the exemption expire the following year.
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