Wall Street's un­wanted trea­suries ex­pose mar­ket cracks

The Pak Banker - - OPINION - Alexandra Scaggs

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.

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