It is no secret that this year has been an extraordinary one for American government debt. Typically, the American treasury bond market is the worlds most liquid bond market even in times of economic downturn. However, in March, the market seized up and as panic about Covid-19 flooded the U.S. To fix this, the Fed bought back as many treasury bonds in a span of two months than it did during the five year period of quantitive easing following the 2008 financial crisis. The market has become flooded with new issuances, but over the past week bond yields have begun to fluctuate as investors weigh the odds of more stimulus now that the election has come to an end.
Regardless of whether or not a stimulus is passed in 2021, the budget deficit will most likely stay 8% above GDP, an ageing population will continue to lift health care spending, and the Fed will be unable to cut rates any lower. These three factors combined with a supersized bond market will amplify the probability of increased market stress and its consequences. According to Randal Quarlers, vice-chairman of the Fed, the "sheer volume" of new issuance could lead to disruption of the U.S gov's ability to borrow and cause tremors around would financial systems.
There are currently two fault lines for these markets. The first one being that when Uncle Sam issues new debt, a group of dealers (mostly banks), are obliged to buy it up at a reasonable price and leave it to pile up on their balance sheets and pushing banks closer to breaching capital requirements set by regulators. This will lead to banks being unable to act as intermediaries for investors, and would ultimately cause investors to pull their money out of markets. The second fault line is the possibility "repo" interest rates spike up drastically in a short period of time. The repo interest rate is extremely important in terms of economic stability and anchors borrowing rates for businesses and households.
There are a few quick fixes to this problem. A temporary exemption of cash and treasuries from banks leverage rations should be made permanent and the number of primary dealers could also be expanded to minimize any issues if some of them get in financial trouble. Nevertheless, it would be wise to implement a more long term solution. The primary-dealer system should be phased out for a clearing house for treasury trades which would let smaller firms dealer with each other rather than having an intermediary middle man clogging up the market. The Fed must also get a grip on rates in the repo market by lending at its target rate to any entity that can provide short term treasuries as a collateral.
https://www.economist.com/leaders/2020/11/07/how-to-fix-the-market-for-treasury-bonds
1 comment:
I assume the feds have poured enough cash into the bond market to send every American more or less $30 thousand this year. The economy is, unfortunately, still tanking. The fixes they have found, hopefully, will be successful.
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