STOCK EXCHANGE OVERVIEW 10/15/2022
NOTASDAQ-Adv: 1,176 Dec: 3,384 NYSE-Adv: 803 Dec: 3,372 (Source: Nasdaq)
The US Treasury Department is asking primary traders of US Treasuries whether the government should buy back some of its bonds to improve liquidity in the $24 trillion market.
Liquidity in the world’s largest bond market has deteriorated this year in part due to rising volatility as the Federal Reserve rapidly raises interest rates to bring down inflation.
The central bank, which had been buying government bonds during the COVID-19 pandemic to stimulate the economy, is now also shrinking the size of its balance sheet by letting its bonds mature without buying more, a move investors fear that it will exacerbate price fluctuations.
The treasury bill market has grown from $5 trillion in 2007 to $17 trillion at the start of 2020, as banks face more regulatory constraints that they say complicate intermediary transactions.
The Treasury is asking dealers about the details of how buybacks might work “to better assess the merits and limitations of implementing a buyback program.”
These include the amount one would have to buy into so-called off-run Treasury bonds, which are older and less liquid issues, in order to “significantly” improve the liquidity of such securities.
The Treasury also questions whether the reduction in volatility in the issuance of Treasury bills following redemptions made for cash and maturity management purposes could be a “significant benefit to the Treasury or investors.”
He further questions the costs and benefits of financing buybacks of older debt with an increase in the issuance of so-called runaway securities, which are the most liquid and common issuances.
“Treasury recognizes the drop in liquidity and hears what the street is saying,” said Calvin Norris, portfolio manager and US rates strategist at Aegon Asset Management. “I think they are studying whether some of these measures could help improve the situation.”
He said buying off-run treasury bills could potentially increase the liquidity of outstanding issues and the buy-back mechanisms could help contain price swings in treasury bills, which are short-term securities.
However, when it comes to longer-dated government bonds, investors have noted that a major constraint on liquidity is the result of a rule introduced by the Federal Reserve following the 2008 financial crisis that forces dealers to hold capital against treasury bills, limiting their ability to take risks, especially in times of high volatility.
“The underlying cause of the lack of liquidity is that the banks – due to the capping of their additional leverage ratios – do not have the capacity to accept more Treasury bills. I consider this to be the most important problem right now,” Norris said.
In April 2020, the Fed temporarily excluded treasury bills and central bank deposits from the additional leverage ratio, a measure of capital adequacy, as an excess of bank deposits and treasury bonds increased the banks’ capital requirements on what are considered safe assets. But he let that exclusion expire, and the big banks had to go back to holding an extra layer of loss-absorbing capital against Treasuries and central bank deposits.
The Advisory Committee on Treasury Borrowing, a group of banks and investors that advise the government on its financing, said Treasury buybacks could improve market liquidity and smooth fluctuations in Treasury bill issuance and cash balances.
He added, however, that the need to fund buybacks through increased issuance of new securities could increase yields and run counter to the Treasury’s predictable debt management strategy if buybacks were too variable in size. or calendar.
The Treasury asks the questions as part of its regular dealer survey before each of its quarterly reimbursement announcements.
Source: Reuters (Reporting by Karen Brettell and Davide Barbuscia; Editing by Chizu Nomiyama and Chris Reese)