The long-simmering idea that the U.S. government should stand ready to buy back Treasury securities from investors to improve market functioning is moving closer to reality.
While the Treasury Department has carried out buybacks in the past—most recently between 2000 and 2002—and while its industry advisors since then have urged it to consider establishing a program, steps taken in that direction last week were more than experts anticipated.
Liquidity metrics for the U.S. government debt market are approaching crisis levels after a year of steep losses for bonds caused by rising inflation and Federal Reserve interest-rate increases, and with the central bank simultaneously cutting some of its holdings, the situation may worsen. Treasury Secretary Janet Yellen expressed concern about it last week.
“When we warned last week that Treasury buybacks might begin to enter the debt management conversation, we didn’t expect them to jump so abruptly into the limelight,” Wrightson ICAP economist Lou Crandall wrote in a note to clients. “September’s liquidity strains may have sharpened the Treasury’s interest in buybacks, but this is not just a knee-jerk response to recent market developments.”
The specific step taken by the Treasury was in its quarterly survey of primary dealers, released Friday in connection with the financing plan to be announced Nov. 2. The 25 dealers were asked for a detailed assessment of the merits and limitations of a buyback program for government securities. When the last financing plan was released in August, the department’s industry advisors on the Treasury Borrowing Advisory Committee recommended further analysis of the issue.
Extreme Volatility
Taken together with Yellen’s recent comments and extreme volatility in the U.K. bond market in recent weeks, the query suggests “that the November refunding will likely show more progress toward opening a buyback facility,” JPMorgan Chase & Co. rates strategists said in an Oct. 14 research note. Strategists at Bank of America Corp. predicted a rollout in May 2023.
The buybacks in 2000 to 2002 were done to allow the Treasury to continue to sell new bonds to maintain its market access at a time when the federal government was running a budget surplus and didn’t need the money. Funds raised by selling new bonds were used to repurchase old ones.
Under current circumstances, which include large federal deficits, a buyback program would have different purposes. They include adding liquidity to parts of the market most in need of it, and allowing Treasury bills to be sold in more consistent quantities, with proceeds used for buybacks of securities less in demand.
Improving Performance
The segment of the market seen to have the most to gain from a buyback program rallied Friday after the survey was released. Twenty-year bonds, reintroduced in May 2020 in quantities that swamped demand, outperformed neighboring sectors. Crandall said that’s misguided, and that debt managers with “a limited amount of cash to devote to improving the performance of the overall market” are “not going to pour a disproportionate amount into salvaging the 20-year sector.”
Treasury liquidity metrics last month reached the worst levels since the market mayhem at the onset of the pandemic. The Bloomberg U.S. Government Securities Liquidity Index—a gauge of deviations in yields from a fair value model—remains near the highest levels since March 2020, when a flight to cash prompted the Fed to begin buying securities to stabilize the market.