The bad news is that the Treasury Department is worried about liquidity stress in the huge market for U.S. Treasuries.
The good news is that the department is moving to do something about the problem.
In its quarterly survey of primary Treasury bond dealers, the department asked the 25 dealers for a detailed assessment of the merits and limits of a program to buy back government securities. This is a big step after the August plan that recommended further study of the issue. It’s now likely that the Treasury Department’s funding plan to be announced on November 2 will show progress toward actually opening a buyback facility, possibly as early as March 2023.
The Treasury Department’s last buyback facility from 2000 to 2002 was used to allow the Treasury to sell new bonds to maintain market access at a time when due to a budget surplus the government didn’t actually need the money. Funds raised by selling new bonds were used to repurchase older issues.
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 Federal Reserve simultaneously working t reduce the size of its balance sheet by not buying bonds to replace those in its portfolio that have matured.
Treasury liquidity metrics in September reached the worst levels since the market chaos during economic shutdowns during the early stages 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.
One sign of liquidity stress is an extreme gap between bid and ask prices in 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, told Bloomberg.
The potential Treasury liquidity problem is especially troubling in the light of recent remarks from Republican House Minority Leader Kevin McCarthy, who is in line to become Speaker if Republicans win a House majority in November, that Republicans would look to hold an increase in the debt ceiling hostage to secure some of the party’s other policy goals.
