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US Treasury asks big banks if they should buy back bonds

Oct 14 (Reuters) – The U.S. Treasury Department is asking primary dealers of U.S. Treasuries whether the government should buy back some of its bonds to improve liquidity in the $24 trillion market.

Liquidity in the world̵[ads1]7;s largest bond market has worsened this year in part due to rising volatility as the Federal Reserve rapidly raises interest rates to bring down inflation.

The central bank, which had bought government bonds during the COVID-19 pandemic to stimulate the economy, is now also reducing the size of its balance sheet by allowing the bonds to mature without buying more, a move that investors fear could amplify price swings.

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The Treasuries market has grown from $5 trillion in 2007 to $17 trillion in early 2020, while banks face more regulatory restrictions that they say make it harder to make intermediate trades.

Treasury is asking negotiators about the details of how buybacks might work “to better assess the benefits and limitations of implementing a buyback program.”

These include how much it will need to buy in so-called off-the-run Treasuries, which are older and less liquid issues, to “meaningfully” improve the liquidity of these securities.

Treasury also questions whether reduced volatility in T-bill issuance resulting from repurchases made for cash and maturity management purposes could be a “meaningful benefit to the Treasury or investors.”

There are also questions about the costs and benefits of financing the buyback of older debt with increased issuance of so-called on-the-run securities, which are the most liquid and current issue.

“Treasury recognizes the decline in liquidity and they are hearing what the street has been saying,” said Calvin Norris, portfolio manager and U.S. fixed income strategist at Aegon Asset Management. “I think they are investigating whether any of these measures can help improve the situation.”

He said that buybacks of government bonds could potentially increase the liquidity of outstanding issues, and buyback mechanisms could help limit fluctuations in the price of Treasury bills, which are short-term securities.

In the case of longer-dated Treasuries, however, investors have noted that a major constraint on liquidity is the result of a rule introduced by the Federal Reserve after the 2008 financial crisis that requires dealers to hold capital against Treasuries, limiting their ability to take on risk, especially in times of high volatility.

“The underlying reason for the lack of liquidity is that the banks — because their leverage ratio is limited — don’t have the ability to take on more government bonds. I see that as the most important issue right now,” Norris said.

The Fed in April 2020 temporarily excluded government bonds and central bank deposits from the supplementary leverage ratio, a capital adequacy measure, as an excess of bank deposits and government bonds increased banks’ capital requirements on what are considered safe assets. But it allowed that exclusion to expire, and large banks had to resume holding an extra layer of loss-absorbing capital against treasuries and central bank deposits.

The Treasury Borrowing Advisory Committee, a group of banks and investors that advises the government on the financing, has said that Treasury repurchases can increase market liquidity and dampen fluctuations in Treasury bill issuance and cash balances.

However, it added that the need to finance buybacks with increased issuance of new securities could increase returns and be at odds with the Treasury’s strategy of predictable debt management if the buybacks were too variable in size or timing.

Treasury asks the questions as part of its regular survey of dealers before each of its quarterly repayment announcements.

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Reporting by Karen Brettell and Davide Barbuscia; Editing by Chizu Nomiyama and Chris Reese

Our standards: Thomson Reuters Trust Principles.

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