The US Treasury is asking major banks to buy back bonds

(Reuters) – The US Treasury is asking major dealers in 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 increased volatility as the Federal Reserve rapidly raises interest rates to bring down inflation.

The central bank, which bought government bonds during the COVID-19 pandemic to stimulate the economy, is now also reducing the size of its balance sheet by allowing its bonds to reach maturity without buying more, a move investors fear could exacerbate price volatility.

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The treasury market has swell From $5 trillion in 2007 and $17 trillion in early 2020, banks face more regulatory restrictions that they say are making intermediary transactions more difficult.

The Treasury is asking merchants to detail how buybacks work “in order to better assess the advantages and limitations of implementing a buyback program.”

These include how much you will need to purchase in so-called unquoted Treasury bonds, which are older and less liquid issues, in order to “purposefully” improve the liquidity of these securities.

The Treasury also questions whether reducing volatility in the issuance of Treasury bonds as a result of repurchases made for cash and maturity management purposes could be a “meaningful benefit to Treasury or investors.”

It also asks about the costs and benefits of financing old debt buybacks while increasing the issuance of so-called current securities, which are the most liquid current issuance.

“The Treasury is acknowledging the low liquidity, and they are hearing what the street is saying,” said Calvin Norris, portfolio manager and US interest rate strategist at Aegon Asset Management. “I think they are investigating whether some of these measures can help improve the situation.”

He said that the repurchase of public treasury bonds can increase the liquidity of pending issues and repurchase mechanisms can help contain the price fluctuations of treasury bonds, which are short-term securities.

However, when it comes to long-term government bonds, investors have noted that one of the major constraints on liquidity is 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 Treasuries, limiting their ability to take on risk. Especially in times of high volatility.

“The underlying reason for the lack of liquidity is that the banks – due to the supplementary leverage ratios being capped – do not have the ability to take on more Treasuries. I see this as the most important issue at the moment,” Norris said.

The Federal Reserve in April 2020 temporarily excluded Treasury bonds and central bank deposits from the supplemental leverage ratio, a measure of capital adequacy, as the increase in bank deposits and Treasury bonds increased bank capital requirements on what are seen as safe assets. But it let that exclusion end and the big banks had to resume holding an extra layer of loss-absorbing capital against Treasury bonds and central bank deposits.

The Treasury Borrowing Advisory Committee, a group of banks and investors that advise the government on its financing, has He said Treasury repurchases can enhance market liquidity and reduce fluctuations in the issuance of treasury bills and cash balances.

However, he added, the need to fund buybacks with increased issuance of new securities could increase returns and conflict with the Treasury’s predictable debt management strategy if buybacks were highly variable in size or timing.

The Treasury asks questions as part of its regular survey of dealers before each quarterly redemption announcement.

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(Reporting by Karen Brittel and Davide Barbuscia) Editing by Chizuo Nomiyama and Chris Reese

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