EDITOR'S NOTE: In a repo situation, the Fed takes US treasuries from big banks, exchanging them for cash to be used as loans before selling the treasuries back. Banks make a profit, but in this current high-interest-rate environment, how many businesses are actually going to be taking out loans? In a reverse repo situation, the Fed takes money out of banks in exchange for Treasuries. Reverse repos have been spiking as banks are trying to offload their deposits which essentially are liabilities. And the larger a bank’s deposits, the more regulatory capital it must hold. Banks are not as willing to play “market maker” for Treasuries, as that too entails a sizable amount of regulatory capital. In the meantime, banks are beginning to set aside loan loss reserves, as they anticipate a significant economic slowdown starting this quarter. Meanwhile, Treasury Secretary Janet Yellen is concerned that the Treasury market may not have adequate levels of liquidity. So, guess what this all means for the market…
(Bloomberg) -- Treasury Secretary Janet Yellen cited concerns about the potential for a breakdown in trading of US Treasuries, as her department leads an effort to shore up that crucial market.
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“We are worried about a loss of adequate liquidity in the market,” Yellen said Wednesday in answering questions following a speech in Washington. The balance-sheet capacity of broker-dealers to engage in Treasuries market-making hasn’t expanded much, while the overall supply of Treasuries has climbed, she noted.
Treasury debt outstanding has climbed by about $7 trillion since the end of 2019. But big financial institutions haven’t been as willing to serve as market-makers, burdened by the so-called supplementary leverage ratio, or SLR, which requires that capital be put against such activity, as well as against reserve holdings.
Yellen noted that the Federal Reserve now has a standing repurchase facility to provide a liquidity backstop to the Treasuries market; that “can be helpful,” she said. She also said that the so-called Group of 30 panel has presented some “good ideas” on reforms that would help strengthen the market, including the possible expansion of central clearing.
Read More: Geithner-Led Group Faults Fed for Slow Work on Treasuries Market
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