The Treasury Department’s top domestic finance official said the US government debt market has functioned well during a year of outsized interest-rate volatility, a regional banking crisis and the recent hack of the world’s largest bank.
Thursday’s remarks by Nellie Liang, the Treasury’s undersecretary for domestic finance, come against a backdrop of widespread concern about the resiliency of the $26 trillion market for Treasuries, the world’s biggest. Regulators have been examining how to strengthen the market since the Federal Reserve engaged in massive emergency purchases when the Covid crisis hit in 2020.
Liang stressed that regulators’ work to bolster resiliency must continue, in prepared remarks at the ninth annual conference on the Treasuries market held at the Federal Reserve Bank of New York. She pointed to possible additional steps to boost transparency about trading volumes and to tamp down excess leverage, particularly in non-centrally cleared bilateral repurchase agreements.
While flagging possible risks from a build-up this year of so-called basis trades—bets that use borrowed money to profit from tiny price discrepancies between futures and the underlying cash Treasuries—Liang also said the practice may provide some benefits. She highlighted the potential of the basis trade to improve liquidity and ultimately buoy demand for US debt.
In what may come as a surprise to some market participants, Liang didn’t offer any new remarks on the idea of a regulatory push for more widespread central clearing of cash Treasuries. A number of observers, including former New York Fed President William Dudley, a columnist for Bloomberg Opinion, have recommended “all Treasury transactions be routed through a central clearinghouse, which stands between counterparties and ensures that adequate collateral is collected.”
ICBC Incident
The Treasury undersecretary instead highlighted how well the market has dealt with shocks this year, including the recent cyber attack against Industrial & Commercial Bank of China Ltd.’s US unit, which provides clearing for Treasuries.
“Despite the various shocks and stresses that emerged during this year, Treasury market functioning has been orderly,” Liang said. “There is still more to complete. Efforts to continue strengthening Treasury market resilience will serve us well over the years to come.”
Liquidity has ebbed at times, yet that movement has been in line with what would be expected during periods of volatility, Liang said—echoing comments in the past by other officials at the Treasury and the Fed.
While “market liquidity conditions deteriorated” in March, when several regional banks failed, they were “not too far out of line with what a regression line would predict for the very high levels of volatility,” Liang said. The episode lifted Treasury transactions to a record high.
Trading Activity
Helping bolster liquidity at that time was increased activity from principal trading firms, a surge that contrasted a decline in PTF engagement during the peak pandemic chaos of March 2020, Liang said.
Earlier this month, there were delays in some trade settlements for days after ICBC’s US unit was hacked—rendering it unable to clear swathes of transactions, with entities responsible for settling the transactions swiftly disconnecting from the stricken systems.
While Treasury Secretary Janet Yellen has also said that she didn’t see an impact of the ICBC disruptions on the bond market, many investors and strategists said it dimmed liquidity—and possibly affected a US debt sale that day.
As for the basis trade, Liang said that this “activity could provide benefits by increasing the liquidity of Treasury securities, improving integration between related cash and derivative market segments, and translating demand for futures into demand for Treasury securities.”
Griffin’s Criticism
“At the same time, we are attentive to the potential risks of a disorderly unwind of leveraged positions, especially those reliant on rolling over financing every day,” she said.
Liang’s remarks may come as a relief to market participants concerned about any regulatory move to eradicate the basis trade entirely. Citadel founder Ken Griffin is among those who have critized regulators over the issue.
An array of metrics show basis trades grew this year to as big as they were in early 2020. Over recent months, regulators have drawn attention to it—with many focused particularly on hedge funds getting funding through repurchase agreements with insufficient safeguards. Part of the officials’ concern is on the financing end, given the majority of US repo dealings—a favored way to get funds for the trade—are done in bilateral uncleared transactions, with over 70% without any haircuts.
Turning to the Treasury’s plans for buying back existing securities in order to bolster liquidity and to improve the department’s cash management, Liang said further guidance will come in the Jan. 31 refunding announcement.
Buyback Plan
“We believe that liquidity support buybacks should improve the willingness of investors and intermediaries to trade and provide liquidity in these securities,” Liang said of so-called off-the-run securities—which are not current benchmarks.
Liang said that the “Treasury intends to be price sensitive in evaluating which buyback offers to accept,” and may not buy the maximum amount set for any particular operation.
The annual gathering at the New York Fed has been part of a push by authorities to shed light on the workings of the business following an extreme bout of volatility in October 2014.
As part of the latest moves to bolster the market, regulators have overseen a move to increase transparency about trades.
“We have made progress towards the public release of detailed secondary market transaction data for on-the-run nominal coupons, with end-of-day dissemination and with appropriate cap sizes,” Liang said. “In line with our ‘walk, not run’ policy, once we have had time to evaluate the effects of disseminating on-the-run transactions, we’ll consider possible next steps for additional transparency.”
This article was provided by Bloomberg News.