As much of the U.S. economy struggles with the burden of rising interest rates, many top investors are questioning the wisdom of buying U.S. Treasuries, even though they pay yields not seen in more than a generation. is holding.
“There’s going to be a debt crisis in this country,” said billionaire investor Ray Dalio. during the interview At a recent event in New York hosted by the Managed Funds Association.
Dalio pointed out that projection This means that the U.S. national debt will explode to more than $52 trillion in 2033, and an increasing proportion of the federal budget will be devoted to debt interest payments.
“How fast? [the crisis] “It’s going to depend on supply and demand issues, so I’m watching that closely,” he said.
U.S. Treasuries BX:TMUBMUSD10Y Big-name investors like Dalio are concerned about the current state of the market and the supply of new bonds expected to hit the market in the coming years if Congress fails to reduce the budget deficit. not only.
In one graph: The 10-year US Treasury yield appears to be pricing in the possibility of a recession. But is it time to buy?
The Biden administration, particularly Treasury Secretary Janet Yellen, has prioritized structural reforms to the Treasury market with the goal of avoiding a Federal Reserve bailout like that required during the September 2019 repo market crisis and market turmoil. They claim that it is a priority issue. It happened in March 2020, at the beginning of the COVID-19 pandemic.
“Today’s U.S. Treasury market reflects heightened uncertainty about the economic outlook,” Yellen said last October. He said the department is “working with financial regulators to advance reforms that improve the ability of the U.S. Treasury market to absorb shocks and disruptions, rather than amplify them.”
But whether regulators are moving quickly and comprehensively enough to avoid another market failure like the one in March 2020, said Yesha Yadav, a law professor at Vanderbilt University who studies financial regulation and market structure. There are still doubts.
“Treasury needs to coordinate with regulators very quickly to advance the agenda here, and it’s not coming together as quickly as it should,” he told MarketWatch.
“There’s a lot of work to do.”
The market for U.S. Treasury securities is regulated by at least five agencies: the Federal Reserve Board, the Federal Reserve Bank of New York, the Securities and Exchange Commission, the Commodity Futures Trading Commission, and the Treasury Department.
Regulators in Washington are moving slowly, and the pace could be even more cautious if the five places have to work together. Therefore, the Treasury Interagency Working Group on Market Oversight was convened to foster cooperation on this issue.
Josh Frost, assistant secretary for financial markets at the Treasury Department, said: Said At last month’s meeting, regulators said they had “made significant progress in developing policies that strengthen the resilience of the U.S. Treasury market, but there is still much work to do.”
Indeed, many of the advances touted in government speeches and reports on the subject are related to policy proposals to strengthen monitoring and data collection of trading venues and dealers, as well as other policies such as promoting ‘everyone to everyone’. Research is inherently promising. A deal that will allow investors to trade U.S. Treasuries directly with each other and a buyback program that will help dealers buy back older, less desirable bonds are expected to begin in 2024.
Mr Yadav said that while these proposals were welcome, they were insufficient “compared to what is happening in markets that are under continued tremendous strain”.
There are no buyers at all
In March 2020, as investors around the world began to understand the economic impact of the coronavirus pandemic (declared a pandemic by the World Health Organization on March 11 of the same year), they panicked and became ruthless. sold as many assets as possible for extra cash.
U.S. stocks have fallen sharply, with the Dow Jones Industrial Average DJIA dropping nearly 10% on March 12th. Even more worrying, according to some accounts, was that the U.S. Treasury market had simply ceased functioning. The demand for cash was so great that it became difficult to find buyers for U.S. Treasury bonds, perhaps the safest and most popular financial instrument in existence.
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“The $1 trillion U.S. Treasury market, the foundation of all other financial transactions, was bobbing up and down in stomach-churning convulsions,” financial historian Adam Tooze writes in his book. his analysis Due to the impact of the coronavirus crisis. “Prices were fluctuating erratically on terminal screens. Or worse, there were no buyers at all.”
The events of 2020 represented the culmination of several episodes of volatility in the U.S. Treasury market, including the yield flash crashes of 2014 and 2018 and the stress in the U.S. Treasury repo market in fall 2019.
These events are motivating regulators to restructure the U.S. Treasury market, which Yadav said is “expected to function when other markets don’t.” “It is largely unregulated in many respects,” he said.
Rise of Argo
The U.S. government bond market has long been dominated by KBWB, a large bank with special ties to the U.S. Treasury and the New York Fed. These so-called primary dealers are required to submit bids during bond auctions and are the counterparties with which the New York Fed buys and sells bonds to implement monetary policy.
The rise of electronic trading over the past 15 years has revolutionized the U.S. Treasury market as high-frequency trading companies deploying sophisticated algorithms take trading away from primary dealer banks.
“What high-frequency trading has done is create more competition and change the incentives of primary dealers from protecting a profitable market to viewing it as a highly competitive market.” said Yadav.
“Dealers have disappeared multiple times, including in March 2020, and high-frequency traders have also disappeared,” she added. “This field is becoming a very competitive field, and we just don’t understand how to deal with the instability that comes from that competition.”
Kevin McPartland, head of market structure and technology research at data analysis firm Coalition Greenwich, said in an interview that non-bank government securities traders such as high-frequency trading firms and hedge funds are intervening to provide liquidity. . I don’t have the ability.
This is partly because post-crisis regulations have limited banks’ ability to manage risks on their balance sheets, and partly because the size of the country’s debt has increased significantly. That’s one reason.
“The upside is that there are more market participants providing liquidity in different ways and for different reasons than they were back then, and markets are much more efficient and electronic than they were 15 years ago,” McPartland said. said.
But regulators don’t have a clear picture of how this new breed of bond dealers, who are increasingly important to the market but often aren’t registered with the Securities and Exchange Commission, operate.
The SEC, led by Gary Gensler, has done more than any other regulator to push for bond market reform, proposing several rules last year that the agency is still considering.
The first would require more securities firms to register with the government as Treasury dealers, and the second would require central clearing of most government bond transactions. The third proposal would strengthen requirements for the electronic platforms traders use to submit bids and offers.
Other regulators, such as the Fed and Treasury, have been less proactive, Yadav said, and there is little evidence that regulators are working together effectively to develop a coherent plan to reform market structures. .
“The Treasury Department and the Financial Stability Oversight Council need to think about a complete restructuring of the markets,” he said, referring to the group of regulators tasked with overseeing the stability of the U.S. financial system. Ta. “For that, [a] Plan how to address transparency and reporting, tightening dealer capacity, and repo market issues. ”
Market extras: See how the turmoil in the government bond market is spreading to global markets in four graphs
deficit reduction
Greenwich Union’s McPartland noted that on the Monday after the Silicon Valley bank failure in March, trading volume in the U.S. Treasury market was $1.4 trillion, barring a few crisis events. They are sounding the alarm on drastic reforms to the U.S. bond market, which has been functioning well.
“For me, a market that sees this much sales during a turbulent period is not a market that has structural problems,” he said.
He said the large amount of government debt the Treasury will have to issue over the next few years poses a potential threat to stability, with budget deficits expected to remain high by historical standards. He said that it is a variable.
“We’re getting into a supply and demand problem,” he said. “So far it’s been very good, and people like the returns these bonds offer today, but I don’t know if that’s going to last forever.”
There isn’t much discussion on Capitol Hill or in the White House about serious bipartisan plans to reduce the deficit. President Joe Biden is proposing big tax increases on the highest-income Americans and businesses, but the Republican-led House of Representatives has failed to unite around the plan, which Republicans hope will reduce the deficit through spending cuts without raising taxes. They generally support the reduction. .
From the archive (November 2022): Some Republican senators are openly talking about cutting Social Security
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Henrietta Treize, director of macro policy research at Veda Partners, said in a recent note to clients that the deficit debate could be reignited as part of a bipartisan compromise to fund the government this year. He said there was reason to believe.
He suggested Congress might agree to set up a “deficit commission” to look into the issue, but that would likely lead to no solutions. “The slim majority and refusal to compromise will prevent the 118th Congress from passing anything other than the bare minimum necessary to keep the government running,” she wrote. “We maintain that significant deficit reductions have not been achieved and that federal spending is more likely to increase than decrease going forward.”
