UNDER STRESS: US TREASURY MARKET REFORM ACCELERATES

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UNDER STRESS : US TREASURY MARKET REFORM ACCELERATES

  • Kit Spicer, Eric Glaas and Stephane Ritz
  • Published: 04 March 2024

 

The $26 trillion US Treasury market is the most important financial market in the world – but it is not immune from episodes of dysfunction. Cracks first surfaced as far back as a decade ago. More recently, Treasury market turbulence in late 2019 and during the COVID pandemic forced the Federal Reserve to intervene with emergency injections of liquidity. Since then, the public and private sectors have been highly focused on identifying and implementing market reforms.

Electronic trading and post-financial crisis regulatory reforms have fundamentally altered the trading dynamics of the US Treasury market. Bank-owned broker/dealer intermediation in US Treasuries and the wider money markets has stagnated, while high frequency trading firms have become an important source of liquidity provision. Treasury repo rates (SOFR) have replaced LIBOR as the industry standard benchmark rate. This changing landscape, coupled with significant financial and operational stresses, has highlighted the need for market reform. 

The US Treasury market has grown significantly since the 2007/2008 financial crisis, reaching $26 trillion as of year-end 2023, and is projected to grow to $48 trillion over the next 10 years to finance large and growing fiscal deficits.


Source: Historical Data from U.S. Department of the Treasury, retrieved from FRED, Federal Reserve Bank of St. Louis; Forecast data from Congressional Budget Office February 2024 Budget Outlook 
 
Policy makers, regulators, industry participants, and observers have identified a series of structural reforms to make the Treasury market function more smoothly in normal times and significantly more resilient to stressed conditions. The stakes are high, as a loss in market confidence would severely hamper the Federal Reserve’s ability to enact monetary policy and could significantly increase the US government’s borrowing costs. 
 
In this paper, we provide a brief background on the Treasury market structure and the recent episodes of turbulence that have been a catalyst for reform. We then explore two recent Securities and Exchange (SEC) Final Rules – one that requires central clearing for most Treasury activity and another that expands the definition of ‘dealer’, capturing more firms active in this space. Finally, we discuss the implications for market participants and the relevant actions that should be taken.

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