‘This is not QE or QT. This is none of those.’ Why the U.S. Treasury is exploring debt buybacks

The US Treasury Department said on Friday it plans to start talks with primary dealers in late October about the possibility of buying back some of its older debt to stave off market disruptions.

The plan, if approved, would mark a milestone in the roughly $22.6 trillion US government bond market, the largest in the world, by providing the Treasury Department with a new tool to manage market liquidity support, a source of growing concern.

See: Treasury Department’s Yellen is concerned about the “loss of adequate liquidity” in the US Treasury market

The proposal comes after the Bank of England was forced to step in with an emergency program to temporarily buy up its sovereign debt and give Britain’s pension funds more time to settle bad bets. Volatility erupted as global central banks worked to combat rising inflation by ending the loose monetary policies that have prevailed for much of the past decade.

Importantly, unlike in the UK, the Treasury’s new proposal is separate from the Federal Reserve’s plans to sharply reduce the size of its balance sheet by phasing out its holdings of government and mortgage bonds at maturity, a process dubbed ” quantitative tightening” is known. (QT) after reaching a record size of almost $9 trillion in two years of “quantitative easing” (QE).

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“This is not QE or QT. It’s none of that,” Thomas Simons, a money market economist at Jefferies, said in a phone interview. “This is the first really serious initial round looking at whether they could do anything. This is far from an announcement. It’s more like fact finding.”

Still, Simons said if the plan takes shape, it could help improve liquidity “where it’s not very good.”

How Treasury buybacks might work

The Treasury Department solicited feedback from traders through Monday, October 24 on a new tool to buy back its runaway securities each year and whether it would “sensibly improve liquidity,” reduce volatility in T-bill issuance, and more would help address concerns in other markets.

The idea would be to absorb the “undesired supply” of runaway securities, which are more difficult to trade when replaced by newer government bond issues or current securities.

“It’s actually a supply management program throughout the year,” Simons said of the Treasury Department’s proposal. “It looks like a tool they could use for the long term and put liquidity where it’s impaired.”

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The Treasury has been meeting quarterly with the trader community for years to gather feedback on how the market is functioning. Buybacks were discussed at previous meetings in August 2022 and February 2015.

Is a UK-style debt crisis looming in the US?

The Federal Reserve began shrinking its balance sheet at a faster rate this fall by maturing more of the bonds it holds. It was also no longer an active participant in the secondary government bond market, raising concerns about potential devastation and who might act as anchor buyers.

Read: The next financial crisis may already be looming – but not where investors expect it to be

While the Fed’s holdings of Treasuries would be considered “off-the-run,” the Treasury Department’s proposal would have “no relation to what the Fed did” to trim its balance sheet, said Stephen Stanley, chief economist at Amherst Pierpoint Securities market observation.

Recent volatility in the UK government bond market may have been a catalyst for the US Treasury to put buybacks back on the agenda, Stanley said, but he wasn’t concerned about their re-emergence as a topic of discussion either.

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“This is the primary way the Treasury Department formally interacts with its principal dealers,” Stanley said.

Jefferies’ Simons went a step further, arguing that if the Bank of England had a parallel, separate counterpart like the US Treasury, it might not have experienced such a “negative reaction from markets” when it launched its temporary bond purchases at the same time it has worked to raise interest rates and otherwise tighten financial conditions to curb inflation.

The benchmark yield for 10-year government bonds TMUBMUSD10Y,
was up 4% on Friday, the highest since Oct. 15, 2008, after rising for 11 straight weeks, according to Dow Jones Market Data.

Sharply higher interest rates have shocked financial markets as the Fed has worked to tame inflation, which remains near a 40-year high. US stocks closed lower on Friday, with the Dow Jones Industrial Average DJIA,
less than 403 points or 1.3% and the S&P 500 SPX,
up 2.4% and the Nasdaq Composite Index COMP,
3.1% lower.


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