U.S. treasury Market Under Scrutiny: Fragilities, Lessons From COVID, and Future Resilience
Recent volatility in the U.S. Treasury market has reignited concerns about its resilience, prompting calls for regulatory reforms and increased clarity. Experts are analyzing lessons learned from past crises, including the market turmoil during the onset of COVID-19 and a recent jolt triggered by unexpected tariff announcements.
The Vital Role of the U.S. Treasury Market
The U.S. Treasury market is the world’s largest thoroughfare for global capital. It’s a massive and intricate system with daily transactions averaging around $900 billion, and reaching as high as $1.5 trillion on particularly active days. Complementing this is approximately $4 trillion in Treasury repurchase agreement (repo) financing occurring each day. Further highlighting its scale, the average daily trading volume in U.S. Treasury futures reached $645 billion in notional value in 2023 and even higher in 2024.
The Treasury market is the backbone of the U.S. financial system.It serves several critical functions, including:
- Financing the U.S. government at the lowest cost to taxpayers.
- Acting as a key channel for the Federal Reserve’s monetary policy.
- Providing the benchmark risk-free yield curve for pricing other assets.
- Serving as a source of safe and liquid assets for investors.
- Facilitating liquidity risk management for financial firms.
Nellie Liang,former Under Secretary of the Treasury for Domestic Finance,emphasized the market’s importance in her April 8,2025,testimony before the House Financial Services Committee:
To serve these critical functions,the Treasury market needs to be deep and liquid. Market participants need to be able to sell Treasury securities without materially impacting the price and at low transaction costs, not only under normal economic conditions but also during periods of uncertainty and stress.
Nellie Liang, former Under Secretary of the Treasury
Emerging fragilities in the Treasury Market
The Treasury market has undergone meaningful transformations in recent decades, creating vulnerabilities that could hinder its ability to withstand major economic shocks. several factors contribute to these fragilities:
- Increased Debt: Large federal deficits have dramatically increased the amount of outstanding Treasury debt.
- Shift in Intermediation: Traditional securities dealers have reduced their market-making activities following the 2008 Global Financial Crisis (GFC) and stricter capital standards.
- Rise of Electronic Trading: Principal trading firms (PTFs), frequently enough with smaller capital reserves than traditional dealers, now dominate electronic inter-dealer markets.
- Price-Sensitive Investor Base: Private funds using leverage or facing redemption pressures have increased their Treasury holdings, while the share held by less price-sensitive foreign official entities has declined.
As Liang noted, the composition of Treasury holders has shifted considerably:
The share of Treasuries held by money market funds, mutual funds, and hedge funds has risen to more than 27%, while the share held by foreign holders has fallen from about 50% in 2015 to 30% now.
Nellie Liang, former Under Secretary of the Treasury
This shift towards more price-sensitive investors can amplify market volatility during times of stress.
The March 2020 Flashback: Lessons From the COVID-19 Crisis
The onset of the COVID-19 pandemic in March 2020 exposed critical vulnerabilities in the Treasury market. The sudden and extreme uncertainty triggered a “dash for cash,” overwhelming the capacity of dealers and other intermediaries to absorb the surge in Treasury sales.
Open-end bond mutual funds and hedge funds, facing margin calls and investor redemptions, sold their most liquid assets – Treasury securities – to raise cash. This surge in selling overwhelmed market makers, leading to a sharp decline in Treasury prices and a corresponding spike in interest rates, particularly for off-the-run securities.
The federal Reserve intervened aggressively, purchasing massive amounts of Treasury securities to restore market functioning. The scale of intervention dwarfed previous efforts. Liang highlighted the contrast:
To put this in outlook, the Fed bought $80 million a month on long-term government debt in the third round of Quantitative Easing (QE3) in 2012. In the week of March 25, 2025, the Fed bought $360 billion in Treasuries.
Nellie Liang, former Under Secretary of the Treasury
The Fed’s intervention, while effective in stabilizing the market, raises concerns about potential conflicts between market stabilization and monetary policy objectives. What happens if the Fed needs to buy Treasuries to maintain market function, but doing so would undermine its goals of controlling inflation or maximizing employment?
Early April 2025: A Tariff-Induced Jolt
In early April 2025, the Treasury market experienced another bout of volatility triggered by unexpected tariff announcements. President Trump’s tariffs, larger and broader than anticipated, created significant economic uncertainty, sending shockwaves through financial markets.
Initially, Treasury yields fell due to recession fears. However, longer-term Treasury yields subsequently rose as investors reassessed the outlook for higher inflation and weaker economic growth.
The rise in the 10-year treasury yield accelerated rapidly,jumping from below 4% on April 4 to a peak of 4.5% on April 8. The 30-year yield also surpassed 5%. this volatility strained market liquidity, as intermediaries reduced risk-taking and increased transaction costs.The spread between Treasury yields and overnight indexed swap (OIS) rates widened, signaling potential deterioration in Treasury market liquidity.
While the Treasury’s auction of 3-year notes was weaker than usual, demand rebounded at the subsequent auction of 10-year bonds after President trump announced a 90-day delay in tariffs for some countries, even though he together increased tariffs on China.
According to Liang, disentangling the causes of the yield spike is complex:
It will take time with detailed data that the financial regulators have to disentangle how much of the rise in longer-term yields was due to basic revisions in the outlook for the economy and inflation, to market illiquidity because of deleveraging pressures that may have forced sales of Treasuries to raise cash, or how much could be from sales because investors repriced the safe-haven quality of Treasury securities.
Nellie Liang, former Under Secretary of the Treasury
Potential factors include leveraged hedge funds facing funding pressures, doubts about Treasury securities as a safe-haven asset, and fundamental revisions in the economic and inflation outlook.
Progress Made: Strengthening Treasury Market Resilience
In recent years, the Inter-Agency Working Group on Treasury Market Surveillance (IAWG), comprising staff from the Treasury, the Fed, and financial regulatory agencies, has been working to bolster Treasury market resilience. key areas of focus include:
- Expanding dealer intermediation capacity.
- Reducing surges in demand for liquidity during stress periods.
- Modernizing market infrastructure.
- Improving transparency and visibility.
Significant progress has been made in several areas:
- Increased data disclosure on Treasury securities transactions and hedge funds.
- New data collection on the bilateral uncleared repo market.
- Treasury buyback programs to improve liquidity in off-the-run securities.
- The Fed’s standing repo facility (SRF) to provide liquidity to dealers in times of stress.
The Road Ahead: Necessary Reforms for a More Resilient Market
Despite the progress made, further reforms are needed to enhance the resilience of the Treasury market. central to this is full implementation of the Securities and Exchange Commission’s (SEC) rule mandating central clearing of Treasury securities and repo transactions.
Of special importance is complete implementation of the Securities and Exchange Commission’s rule to mandate more central clearing of Treasury and repo. Central clearing is used for other assets and can reduce risk by standardizing risk management requirements and increase intermediation capacity through multilateral netting.
Nellie Liang, former Under Secretary of the Treasury
Central clearing, common in other asset classes, can reduce risk by standardizing risk management and increasing intermediation capacity. However, implementation faces operational, regulatory, and accounting challenges, leading to extended deadlines: December 2026 for Treasury securities and June 2027 for Treasury repo.
Other potential reforms include:
- Modifying the Supplementary Leverage Ratio (SLR): Adjustments to the SLR could encourage bank intermediation in the Treasury market without compromising safety and soundness. One potential change would be to exclude central bank reserves and potentially Treasury securities held for trading from the SLR calculation.
- Reducing Liquidity Mismatches in Open-end Bond Funds: Requiring open-end bond funds to reduce liquidity mismatches could mitigate forced Treasury sales during stress periods.
- Supervising hedge Fund Leverage: Enhanced supervision of hedge fund leverage in trades like the cash-futures basis trade could prevent disorderly unwinds of positions. This scrutiny can be aided by data from new bilateral repo transactions and Form PF filings.
| Reform Area | Specific Action | Potential Benefit |
|---|---|---|
| Central Clearing | Implement SEC rule for mandatory central clearing | Reduces risk,increases intermediation capacity |
| Supplementary Leverage Ratio (SLR) | exclude reserves/Treasuries from SLR (with adjustments) | Encourages bank intermediation |
| Open-End Bond Funds | Reduce liquidity mismatches | Mitigates forced Treasury sales |
| Hedge Fund Leverage | Supervise and limit excessive leverage | Prevents disorderly unwinds |
Liang emphasizes the interconnectedness of these reforms:
These reforms are complementary and interconnected,and,in my view,all should continue to be pursued. Prudent changes to the SLR would not on its own significantly improve intermediation and strengthen resilience in stress periods, especially as the amount of Treasury debt continues to grow. Central clearing and also incentives from the SRF are needed to increase intermediation capacity, and stronger rules and supervision to reduce liquidity mismatch and leverage of investors also are needed.
Nellie Liang, former Under Secretary of the Treasury
What reforms are proposed to enhance Treasury market resilience?
U.S.Treasury Market Under Scrutiny: An Interview with Dr. Eleanor Vance
Understanding Treasury Market Fragilities
Archyde News: Welcome, Dr. Vance. Thank you for joining us today. The U.S. Treasury market is under intense scrutiny. Coudl you provide a simplified overview of its importance and the current challenges it faces?
Dr.Eleanor vance: Certainly. The U.S. Treasury market is the bedrock of the global financial system. It finances the U.S.government, provides the benchmark for all other asset pricing, and offers a safe haven for investors. Though, increased debt, shifts in market intermediation, and a changing investor base are creating vulnerabilities.
Archyde News: The article highlights the role of principal trading firms and a shift towards a more price-sensitive investor base. How do these factors contribute to market fragility?
Dr. Eleanor Vance: Traditional dealers have stepped back, and PTFs often operate with less capital. This can reduce market-making capacity. Moreover, more and more Treasuries are held by entities like hedge funds and money market funds, which can amplify volatility during times of stress. When facing margin calls or investor redemptions, they’re compelled to sell, irrespective of price, which exacerbates market turmoil.
Lessons from the COVID-19 Crisis and Tariff Proclamation
Archyde News: The COVID-19 crisis in March 2020 exposed meaningful vulnerabilities. What were the key takeaways from that event, and how does the recent volatility triggered by tariff announcements echo those lessons?
Dr. Eleanor Vance: The pandemic created a “dash for cash,” overwhelming the market’s capacity. The Federal Reserve had to intervene massively. The tariff announcements in April echoed this. Uncertainty driven by unexpected policy changes led to rapid shifts in yields and liquidity concerns, stressing market function. Both events highlight the need for market resilience even in times of extreme stress.
Archyde News: The article mentions the speed at which yields shifted. What specific indicators or market signals are crucial for monitoring such volatility?
Dr. Eleanor Vance: Observing the bid-ask spreads in the Treasury market is critical. When spreads widen, it signals deteriorating liquidity. Also, the yield curve movements themselves – the speed and magnitude of changes – offer valuable insights. The spread between Treasury yields and OIS rates is another indicator of how the market is functioning.overall market volume needs to be taken into consideration.
The Road Ahead: Reforms and Resilience
Archyde News: Several reforms are proposed to enhance Treasury market resilience. Could you elaborate on the importance of central clearing, adjustments to the Supplementary Leverage Ratio, and the supervision of hedge fund leverage?
Dr.Eleanor Vance: Absolutely. Central clearing standardizes risk management and increases intermediation capacity. Adjusting the SLR,perhaps excluding reserves and trading Treasuries,could incentivize bank activity in the market without jeopardizing safety. Enhanced supervision of hedge fund leverage, focused on cash-futures basis trade, is important to prevent disorderly unwinds and to have confidence the market can weather the issues as well.
Archyde News: The article is highlighting that the mentioned reforms are interconnected. What do you think is the most important immediate step to build a more resilient U.S. Treasury market,and why?
dr. Eleanor Vance: While all the reforms are valuable, the immediate, critical step is the full implementation of the SEC’s rule for mandatory central clearing for Treasury securities and repo transactions. It lays the groundwork for manny of the other improvements and will reduce systemic risk across the sector.
Archyde news: A final thought-provoking question for our readers would be: What are some key considerations for market participants to navigate potential future volatility within this evolving market surroundings? We invite our readers to share their insights in the comments below.
Dr. Eleanor Vance: That is a very important question. Market participants should stay informed, continuously assess risk management strategies, and consider the impact of policy changes. Diversification and liquidity planning is also essential to the success of the future. The U.S. Treasury market is crucial to global finance, and its resilience requires constant vigilance and proactive measures.
Archyde News: Dr. Vance, thank you for your valuable insights.
