The long-simmering idea that the US 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 advisers 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 US 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 advisers 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 UK 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 US 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.
“You can drive a truck through the bid-ask spread” for some securities, Deborah Cunningham, chief investment officer of global liquidity markets and senior portfolio manager at Federated Hermes, said in a Bloomberg Television interview Oct. 3.
The extremes of volatility in US Treasuries are adding to the strains evident across global assets, said Chamath De Silva, a senior portfolio manager for Sydney-based BetaShares Holdings, which oversees the equivalent of $2.7 billion in fixed income exchange-traded funds.
“That does have actual implications for liquidity at a market structure level, and if there’s elevated rate volatility dealers have less capacity to warehouse risk across government bonds as well as spread products,” De Silva said.
Small Beginning
Bank of America strategists, who’ve been advocating for a buyback program since March 2020, envision an initially small one that won’t aggressively increase benchmark bill or coupon sizes for funding.
“Treasury debt managers are risk averse, careful, and deliberate policy makers,” strategists led by Mark Cabana wrote in a note. “They rightfully do not rush decisions. Buyback implementation will likely be no different.”
Not addressed in the survey questions was the possibility that buybacks may be used in a limited way to help the Treasury manage the its next encounter with the federal debt ceiling, as Wrightson’s Crandall expects.
A “more rapid and aggressive” implementation can’t be ruled out, though, if Treasury market functioning breaks down, the Bank of America strategists said.
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