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The pressure to reshape the US Treasuries market is mounting

The US $ 22 trillion Treasury bond market is ill-equipped to fund the US spending packages that will eventually be tabled by Congress. The administration and the market surveillance authorities know this and are preparing to formally develop a new market structure.

Work began even before the Federal Reserve Board of Directors confirmed (or reaffirmed) the next chairman and vice chairman. Officials such as Nellie Liang, Undersecretary of the Treasury for Domestic Finance, and Gary Gensler, Chairman of the Securities and Exchange Commission, have already made initial sketches.

Their common concept is to move to a market where liquidity is provided by a variety of large and small participants, rather than a few dozen “primary dealers” and 50 large hedge funds.

Gensler put it this week: “The principle is something that mankind has understood since ancient times. If you take vendors into a public square and they compete to sell apples, the prices are clear and city dwellers benefit from these competitive prices. “

Treasury, the Fed and regulators like Gensler are plagued by the collapse of the treasury market in March last year, which rocked global markets. A paper co-authored by Liang said, “Large and widespread bond sales. . . The liquidity supply of the securities dealers, who act as brokers in the bond market, is overwhelmed.

Okay, so never again. However, the budding market transformers do not yet have the necessary information about how the existing market machine works.

A strategist at a major retailer describes the March episode last year: “It was like 2007 and 2008; nobody knew where all the risk was in the system and how it was tagged (rated). . . It is all a waste of time until you figure out where the leverage is. And this leverage mainly takes place in Treasuries. “

Check out the New York Fed’s October 6 study, Sizing Hedge Funds’ Treasury Market Activities and Holdings. This is defined as “the sum of your long and short exposure” to both government bonds and derivatives.

That was an astonishing $ 2.4 trillion up to February 2020, more than the amounts now being negotiated for the so-called Congressional Draft Congressional Budget. When the funds dropped $ 173 billion of that in March 2020, it hurt.

Note that the study was published a year and a half after the traumatic events. Some of the data are estimates that “follow an algorithm” and so on. The functioning of the treasury market may have been “affected” by the activities of hedge funds trading in the relative value of the assets. But who can be sure?

And this delayed information does not tell you how many times a treasury security has been loaned out by investors, banks and hedge funds to market participants for temporary reuse as high-quality collateral for quick foreign exchange or interest rate derivative transactions.

According to statistics collected by the IMF, the 18 largest traders in the world were holding $ 9.4 trillion of such collateral easier at the end of 2020. It also helps to relax the financial terms as a form of secured leverage. But has this lending or re-lending become too quick and unstable?

Despite the uncertainties in the data, officials like Liang, Gensler and Fed chairman Lael Brainard want to investigate how “central clearing” of all treasury transactions can reduce reliance on hedge funds and the big traders. This complex mechanism would act as a seller for all buyers and a buyer for all sellers at the same time.

Sifma, a US securities market federation, argued in a March release: “Even if most treasury operations were centralized, it is highly unlikely that enough capacity would have been freed up to access the dash-for-cash absorb. from investors that took place last year. “

One could argue that Sifma focuses on the interests of its members, not those of the public. But Manmohan Singh, an IMF market installation expert, claimed in a May 2021 release that central clearing of treasuries would necessarily be linked to clearing of treasury derivatives through the CME.

In his view, “that would cram more of the world’s major bond market into institutions that are already too big to fail, which can ultimately be attributed to the taxpayer. That would likely require more control by the Fed and perhaps the guarantee of more liquidity lines. “

I have to admire the courage of tax officials and regulators to hack through the jungle of reshaping the financial market. I wonder if or when they’ll show up with a plan.

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