Shown in this image dated February 14, 2022 is US dollar banknotes. REUTERS/Dado Ruvic/Illustration acquire license rights
JACKSON HOLE, Wyoming, Aug 25 (Reuters) – To prevent the $25 trillion US Treasury market from bogging down in a future crisis like it did at the start of the COVID-19 pandemic , it could mean the Federal Reserve stands by for unlimited bond purchases if needed, suggests new analysis released on Friday.
“US Treasuries are expected to provide excellent safe haven services in the ‘competition’ for cash given the expected depth and liquidity of the market in which they trade, even during a crisis when many large investors are simultaneously liquidating their Treasuries .” Darrell Duffie, a professor at Stanford University Business School, wrote in a talk presented at the Kansas City Fed’s annual economic symposium in Jackson Hole, Wyoming.
But that didn’t materialize in March 2020, largely because traders simply didn’t have enough room on their balance sheets to handle the spate of Treasury selling by investors panicked by the uncertainties of a global pandemic.
Treasury trading almost halted, threatening the functioning of global financial markets until the Fed stepped in and bought hundreds of billions of dollars worth of bonds, helping to free up space on traders’ balance sheets.
“The impact of dealer capacity limits on Treasury market resilience could worsen in the coming years as the amount of Treasury securities that investors may want to liquidate in a crisis grows far faster than the size of dealer balance sheets,” Duffie said the Assembly of Central Bankers. “Securing the liquidity of this market through transparent public sector purchase programs will further strengthen the resilience of the market.”
Future bouts of Treasury market illiquidity could also be made less likely by greater use of central clearing, Duffie wrote, and by changing the way regulators assess banks’ capital levels.
Tax authorities temporarily made such a change after March 2020, but allowed the so-called Supplementary Leverage Ratio exemption to expire a year later.
Other changes could include technical changes to the market function to encourage direct buying and selling without dealer intermediation, Duffie wrote.
Reporting by Ann Saphir; Edited by Chizu Nomiyama
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