Wall Street's unwanted treasuries expose market cracks
THE world's biggest bond dealers are getting saddled with Treasuries they can't seem to easily get rid of, adding to evidence of cracks in the $13.3 trillion market for U.S. government debt. The 22 primary dealers held more Treasuries last month than any time in the last two years, Federal Reserve Bank of New York data show. While at first glance that may suggest a bullish stance, the surge in holdings is more likely the result of investors including central banks dumping the debt on the firms, said JPMorgan Chase & Co. strategist Jay Barry. Foreign official accounts sold a net $105 billion of the securities in December and January, an unprecedented liquidation, Treasury Department data show.
Strategists say there are signs that the buildup of Treasuries held by dealers is having a ripple effect, mucking up the plumbing of the financial system. While the holdings show they did their job by soaking up the supply from central banks raising cash to support their currencies, it's adding to questions about the resilience of the world's most important market. The Treasury Department is already looking into whether the market isn't operating as smoothly as it should. "This was a lot of dealers doing what they are supposed to do -- provide liquidity," said Scott Buchta, head of fixed-income strategy at Brean Capital LLC in New York. "But the liquidity providers right now are getting the short end of the stick. It's harder for dealers to offload these securities because the market depth just isn't there."
Primary dealers' stash of Treasuries reached as high as $121 billion last month, the most since October 2013 and up from about $9 billion in July of last year. They held $111 billion as of March 9, almost double the average for the last five years.
As the world's biggest bond dealers -including banks such as Bank of America Corp., Goldman Sachs Group Inc. and JPMorgan -- struggled to get rid of the burgeoning pile of debt, the premium for the newest, easiest-to-trade Treasuries soared to the highest since 2011. The firms' efforts to hedge all the Treasuries collecting on their balance sheets also roiled the futures market and a cru- cial corner of the financial system where traders lend and borrow securities overnight. All of this has been happening as the bond-trading business has been coming under pressure. Last year, the world's biggest banks generated the lowest revenue from fixed-income products since 2008, according to research firm Coalition Development Ltd. Critics contend that regulations enacted since the financial crisis, such as increasing capital requirements and curtailing leverage, restrict dealers' willingness to make markets. Officials say the rules have made the financial system safer. The Treasury Department is conducting its first comprehensive review of the government-debt market's structure since 1998. The review was prompted by a 12-minute plunge and rebound in yields on Oct. 15, 2014. The Treasury 10-year note yield was little changed at 1.87 percent as of 9 a.m. London time. "Without question, the reforms adopted following the crisis have created a stronger, more resilient system," Antonio Weiss, counselor to Treasury secretary Jack Lew, said in prepared comments March 16 in Washington. Dealers moved to minimize the risk of holding so many tough-to-unload securities by selling, or shorting, benchmark notes, said Barry of JPMorgan. They had the biggest bearish position in the newest 30-year bonds since May in the week ended March 9, according to a Credit Agricole SA analysis of New York Fed data.
Part of the fallout was seen in the $1.6 trillion market for repurchase agreements, or repos, where Wall Street goes to exchange securities for overnight cash.
The combination of dealer demand, a global government-debt rally and reduced auction sizes caused a shortage in the repo market for the securities needed to close short positions in 10-year debt. Failures to deliver 10-year notes surged in the week ended March 9 to the most since at least 2013. For all Treasuries, failures reached the highest since the financial crisis, New York Fed data show. Demand was so great for the benchmark 10-year note that its repo rate traded at about negative 3 percent for more than a week, before an auction of the debt settled March 15 and eased the shortage. At that level, the cost of borrowing the security in the repo market was steeper than the 3 percent penalty for uncompleted trades, leading more traders to opt to let deals fail.