The Treasury market, valued at $26 trillion, has showcased remarkable resilience in 2021, even amidst significant fluctuations in stocks and bonds, a surge in U.S. debt issuance, and the Federal Reserve's reduction of its balance sheet.
In a recent progress report by five U.S. regulatory agencies focusing on implementing reforms to bolster transparency and resilience in Treasury securities, it was noted that the supply of bills increased by approximately $1.27 trillion by the end of September, as compared to the end of May. This represents the second-largest increase in dollar terms (second only to 2020) and the third largest in percentage terms (trailing behind 2008-2009 and 2020).
Despite heightened volatility and a surge in trading volumes, the report emphasized that indicators of stress remained within historical ranges.
During recent weeks, markets experienced unease as the 10-year Treasury yield (BX:TMUBMUSD10Y) and the 30-year rate (BX:TMUBMUSD30Y), which serve as benchmarks for financing the U.S. economy, briefly reached 5%, a level not seen in 16 years.
Nevertheless, the Treasury market managed to function efficiently throughout the year, defying concerns that arose in March about a potential banking crisis. These worries caused a level of volatility reminiscent of the global financial crisis in 2007-2008 and other alarming events. Additionally, 2021 witnessed a near-complete transition away from the scandal-ridden London Interbank Offered Rate (LIBOR) reference rate, which had long been viewed as a potential destabilizing force in markets.
Treasury's Plans for Market Liquidity Support
The Treasury Department is set to introduce a new buyback facility in the coming year, aimed at enhancing market liquidity. The facility will enable holders of off-the-run securities to retire older and less liquid U.S. debt in a systematic manner, starting with primary dealers.
Improving Reporting and Transparency
A working group, composed of the Treasury, various Federal Reserve entities, and the U.S. Securities and Exchange Commission, aims to strengthen reporting practices among Wall Street dealers. The objective is to enhance public transparency regarding trading activities and require hedge funds operating in the sector to disclose more information.
Responding to Pandemic Shocks
The proposed reforms in the Treasury market stem from the shocks caused by the 2020 pandemic. These shocks temporarily disrupted liquidity, leading the Federal Reserve to intervene and provide substantial support to financial markets.
Addressing Long-term Challenges
However, liquidity challenges have been evolving for years. Following the financial reforms that emerged in the wake of the 2008 crisis, Wall Street banks have gradually withdrawn from the Treasury market. Furthermore, the market itself has expanded significantly, growing approximately fourfold from its size of around $6 trillion in 2008.
Resilience in Times of Volatility
Despite this year's unprecedented volatility, the Treasury market has proven resilient. Crisis scenarios have been thoroughly tested, yet the system remains intact according to Kent Engelke, chief economic strategist at Capitol Securities Management. He stated, "The system has been very stress tested and it has not broken."
Market Response and Outlook
On Monday, the 10-year yield dropped to 4.65%, following the Treasury's reduction in its fourth-quarter borrowing estimate and comments from Fed Chair Jerome Powell. Powell suggested that higher bond yields might effectively address inflation concerns, alleviating the pressure on the central bank.
In terms of stock performance on Monday, the Dow Jones Industrial Average rose 0.1%, and the S&P 500 index added 0.2% after fluctuating between minimal gains and losses. The Nasdaq Composite also experienced a 0.3% increase amidst the session's volatility.
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