The US Treasury is asking major banks whether to buy back bonds

The US Treasury is asking major banks whether to buy back bonds
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Oct 14 (Reuters) – The US Treasury Department is asking US Treasury primary dealers whether the government should buy back some of their 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 US Federal Reserve quickly hikes interest rates to curb inflation.

The central bank, which had been buying government bonds to stimulate the economy during the COVID-19 pandemic, is now also reducing the size of its balance sheet by phasing out its bonds without buying more, a move that is doing so investors Fear could exacerbate price volatility.

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The Treasury market has swollen from $5 trillion in 2007 to $17 trillion in early 2020, while banks face more regulatory restrictions that they say are making it harder to broker deals.

The Treasury Department is asking dealers for the details of how buybacks might work “to better appreciate the merits and limitations of implementing a buyback program.”

That includes how much it would need to buy in so-called off-the-run Treasuries, which are older and less liquid issues, to “sensibly” improve the liquidity of those securities.

The Treasury also questions whether reduced volatility in Treasury bill issuance as a result of repurchases for liquidity and maturity management purposes could be a “significant benefit to the Treasury or investors.”

She also questions the costs and benefits of funding buybacks of older debt through increased issuance of so-called on-the-run securities, which are the most liquid and recent issuance.

“The Treasury acknowledges the drop in liquidity and hears what the streets are saying,” said Calvin Norris, portfolio manager and US interest rates strategist at Aegon Asset Management. “I think they are investigating whether some of these measures could help improve the situation.”

He said buying back maturing government bonds could potentially increase the liquidity of outstanding issues and buyback mechanisms could help contain price volatility for Treasury bills, which are short-term securities.

For longer-dated government bonds, however, investors have found that significant liquidity constraints are the result of a rule introduced by the Federal Reserve in the wake of the 2008 financial crisis that requires traders to hold capital against government bonds, limiting their ability to take risks, particularly in periods of high volatility.

“The underlying reason for the lack of liquidity is that banks – due to the cap on their additional leverage ratios – are unable to borrow more government bonds. I see that as the most important issue right now,” Norris said.

The Fed temporarily excluded government bonds and central bank deposits from the supplemental leverage ratio, a capital adequacy measure, in April 2020 as an excess of bank deposits and government bonds increased banks’ capital requirements for safe-haven assets. But as this exclusion expired, large banks were again forced to hold an additional layer of loss-absorbing capital against government bonds and central bank deposits.

The Treasury Borrowing Advisory Committee, a group of banks and investors that advises the government on its funding said that government bond purchases could increase market liquidity and dampen volatility in Treasury bill issuance and cash on hand.

But it added that the need to fund buybacks by issuing more new securities could increase yields and run counter to the Treasury Department’s strategy of predictable debt management if the buybacks were too disparate in size or timing.

The Treasury Department asks the questions as part of its regular survey of merchants ahead of each of its quarterly refund announcements.

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reporting by Karen Brettell and Davide Barbuscia; Edited by Chizu Nomiyama and Chris Reese

Our standards: The Thomson Reuters Trust Policy.

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