Alexandra Harris
BloombergOctober 27,2022

  • Program may help market functioning, but is not a cure-all
  • Facility helps correct supply-demand imbalances, analysts say

The Treasury is likely to move ahead with plans to buy back securities from investors to improve market functioning, though it’s still unclear what the primary objectives of such a program should be and whether it will be effective at all.

Secretary Janet Yellen on Monday flagged the potential for buybacks of certain US government securities after the department queried primary dealers for the potential for the maneuver to improve liquidity in the nearly $24 trillion Treasury market. When the last financing plan was released in August, the department’s industry advisers on the Treasury Borrowing Advisory Committee recommended further analysis of the issue.

Why the US Treasury Could Start Buying Back Its Bonds: QuickTake

Liquidity metrics for the US government debt market are approaching crisis levels after a year of steep losses for bonds caused by rising inflation and Federal Reserve interest-rate increases, and with the central bank simultaneously cutting some of its holdings, the situation may worsen.

Wall Street strategists are largely in agreement that a Treasury buyback program is not a panacea for a deterioration in liquidity and regulatory solutions are needed. They also agree that it could help correct supply and demand imbalances plaguing the very front end and back end of the Treasury curve. Still, opinions vary as to the timing and size of the program, though most acknowledge the risks that something could be in place sooner if liquidity strains worsen.

What the strategists say

  • RBC Capital Markets (Blake Gwinn)
    • Treasury is going to place a “very high bar” on taking a more activist, regular, and potentially lasting role as a liquidity provider in secondary markets
    • Buybacks aren’t a monolith, and a program could be structured in different ways with different purposes in mind; for now, markets most focused on providing a liquidity outlet for off-the-runs via regular operations, and swapping less liquid issues to increase the size of on-the runs
    • It seems more likely the Treasury will pursue ad hoc uses for buybacks, such as serving as a buyer of last resort in the even of an “acute liquidity breakdown,” or boosting bill supply
  • Morgan Stanley (Guneet Dhingra, Martin Tobias)
    • The size of the 2000-2002 buyback program amounted to $67.5 billion so adjusting for a Treasury market that’s about seven times larger puts the annual equivalent around $250 billion
    • Although buybacks could be funded with larger on-the-run issuance, this may only delay the existing intermediation issues to some point in the future as the larger on-the-runs eventually become off-the runs; larger auction sizes may result in more frequent tails
    • Treasury could finance buybacks with increased T-bill issuance, though it creates the optics of an Operation Twist-type program
  • TD Securities (Gennadiy Goldberg and Priya Misra)
    • Treasury should have a large “buyback envelope” that lays out the potential scope of purchases during the year, but announce purchase sizes and sectors a week ahead of time, “giving them maximum flexibility on which sectors to purchase”
    • A well-designed and consistent Treasury buyback program is likely to help improve market functioning, it’s not a panacea for deterioration in liquidity, and only a change in bank regulation to lower the cost of balance sheet may help
    • Buyback program would tighten on-the-run versus off-the-run spreads, richen 20s on the fly and old 20s on the curve, though the impact on swap spreads is less clear
  • Wrightson ICAP (Lou Crandall)
    • Treasury could frame a 2022-2023 buyback program as having two goals: cash and short-term debt management, and providing a liquidity backstop for the secondary market
    • It’s doubtful either of the two objectives by themselves would be enough to persuade Treasury to dust off its buyback platform, but the “confluence of cash-management and market-functioning motivations may be enough to push the buyback proposal over the line in today’s circumstances”
    • Cautiously optimistic Fed’s “holistic” review of bank capital requirements will eventually lead to some form of leverage relief, but in the interim buyback operations may be a “useful expedient while the regulatory debate plays out”
  • JPMorgan (Jay Barry and others)
    • A buyback facility could come to fruition as early as February 2023, initially funding it via Treasury bills in early stages
    • There’s scope for Treasury to utilize buybacks in order to either support liquidity in off-the-runs or to smooth out its maturity profile, resulting in less volatile issuance in T-bills
    • Still, it’s not possible that Treasury can be “100% opportunistic in implementing such a facility, in order to maintain its credibility as a ‘regular and predictable’ borrower”
  • Goldman Sachs (Praveen Korapaty and others)
    • Treasury buyback program would have to be around $200b-$250b to be sufficient, given that dealer inventories oscillated around those levels in the later stage of the Fed’s last quantitative tightening program in 2018-2019
    • Buybacks used more broadly could also allow Treasury to achieve other debt management goals such as optimizing the weighted average maturity of its debt, managing the Treasury General Account, and the reduction of debt maturity peaks
    • While “properly designed” buybacks will likely improve liquidity on the margin, “it does not materially increase intermediation capacity, and would not prevent market breakdowns in times of acute stress”
  • Jefferies (Thomas Simons, Aneta Markowska)
    • “Buybacks that sop up illiquid bonds that have spotty demand from investors seems like a very good idea, however the benefits do not come free of cost” and there are there are a number of questions that need to be answered
    • Trying to fine-tune the amount of supply available for certain bonds to maintain good liquidity “is going to be very difficult”
    • Regular and predictable issuance is one of the hallmarks of the Treasury market so that should be the best approach for buybacks, as well — starting small and funding purchases mostly with bills would be optimal, in addition to committing to a schedule that stretches several months into the future in order to get the market adjusted
  • Deutsche Bank (Tim Wessel, Steven Zeng, Matthew Raskin)
    • An off-the-run buyback program is a much better option than Fed asset purchases for supporting liquidity, as it avoids conflating purchases with monetary policy goals
    • Drawbacks come from the unknown dynamic costs, such as whether on-the-runs cheapen to fund new issuance. Buybacks also doesn’t create any more intermediation capacity
    • Any program that makes bill issuance more stable and predictable should improve money-market functioning, but it may be more difficult to implement
  • Barclays (Anshul Pradhan and Andres Mok)
    • Program of $200 billion or more per year could be meaningful in the context of fluctuations in primary dealer holdings
    • Higher issuance of on-the-run securities may reduce the liquidity premium and reduce the benefit of buying back seasoned “cheap” securities by issuing “rich ones,” which “could be significant enough to be considered in the cost-benefit analysis of the program”
    • Other implementation issues to consider include how much the float will be reduced — and it will only be known ex-post if it has been reduced too much — and whether Treasury will exclude securities that command a liquidity premium, like those trading special in repo, and cheapest-to-deliver securities in Treasury futures contracts
  • Credit Suisse (Jonathan Cohn)
    • Envision a buyback facility put in place as early as first quarter 2023 as the TBAC examination in the August refunding and extensive questioning in the survey “suggest serious consideration and a sense of urgency”
    • Critical question is whether the buybacks would effectively be duration- or WAM neutral, though a WAM-shortening program could be “quite attractive” given excess liquidity and captive money-market demand at the front-end, and bill supply undershooting the desired percentage of outstanding debt
  • Bank of America (Mark Cabana and others)
    • Program may start in May 2023 given that Treasury is likely to collect market participant views at the November 2022 refunding, provide feedback in February 2023 and formally announce terms in May
    • Buybacks will likely start small given that Treasury won’t want to “materially increase benchmark bill or coupon sizes aggressively to fund the program,” though they could grow to $100b-$250b/year
    • Buybacks should initially be WAM neutral but may be used to shorten WAM over time as they could be used to address two great supply/demand imbalances on the Treasury curve: supply constraints on the front end and too much supply on the back end
  • Citigroup (Jason Williams)
    • A Treasury buyback facility won’t have “much relevance” in preventing a “dash-for-cash event,” though it could help improve liquidity marginally as there are a lot of challenges in the market
    • Program could be more of a debt management tool, likely introduced in very small size and very targeted to help smooth out issues, and could be expanded over time to assist liquidity when markets become dysfunctional
    • The Fed remains the only backstop if Treasury markets “malfunction materially,” at which point the central bank could either reinvest maturing securities into off-the-run coupons, or let QT continue but sell their T-bills for off-the-run coupons, which is effectively an Operation Twist