As much of the U.S. economy struggles with the burden of rising interest rates, many top investors are questioning the wisdom of buying U.S. Treasurys \u2014 even though they are paying yields not seen in more than a generation. <\/p>\n
\u201cWe\u2019re going to have a debt crisis in this country,\u201d billionaire investor Ray Dalio said during an interview at a recent event in New York organized by the Managed Funds Association. <\/p>\n
Dalio pointed to projections showing that the U.S national debt will explode to more than $52 trillion in 2033, with a growing share of the federal budget dedicated to paying interest on the debt. <\/p>\n
\u201cHow fast [the crisis] transpires,\u201d he said, \u201cis going to be a function of that supply-demand issue, so I\u2019m watching that very closely.\u201d <\/p>\n
Big-name investors like Dalio are not the only ones concerned about the state of the Treasury
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\n market and the supply of new bonds set to hit the market in coming years if Congress can\u2019t cut the budget deficit.<\/p>\n
In One Chart:<\/strong> The 10-year Treasury yield looks priced to cause a recession. But is it time to buy? <\/p>\n The Biden administration \u2014 and notably Treasury Secretary Janet Yellen \u2014 has claimed reforming the structure of the Treasury market as a top priority, with the goal of avoiding Federal Reserve bailouts like those required during the repo-market crisis of September 2019 and during the market gyrations that occurred in the earliest days of the COVID-19 pandemic in March 2020. <\/p>\n Yellen said last October that \u201cthe Treasury market today is reflecting greater uncertainty about the economic outlook.\u201d Her department, she said, is \u201cworking with financial regulators to advance reforms that improve the Treasury market\u2019s ability to absorb shocks and disruptions, rather than to amplify them.\u201d <\/p>\n Questions remain, however, as to whether regulators are moving fast enough and comprehensively enough to avoid another market failure like that of March 2020, according to law professor Yesha Yadav of Vanderbilt University, who studies financial regulation and market structure. <\/p>\n \u201cThere should be huge urgency in the Treasury coordinating with regulators to push an agenda forward here, and it\u2019s not coming together as fast as it should,\u201d she told MarketWatch. <\/p>\n The market for U.S. Treasurys is regulated by no fewer than five entities: the Federal Reserve Board, the Federal Reserve Bank of New York, the Securities and Exchange Commission, the Commodity Futures Trading Commission and the Treasury Department itself. <\/p>\n Regulators in Washington move slowly, and when five must work in tandem the pace can be even more deliberate, which is why the Inter-Agency Working Group on Treasury Market Surveillance has been convened to promote collaboration on the issue. <\/p>\n Josh Frost, assistant secretary for financial markets at the Treasury, said at a conference last month that regulators have \u201cmade significant progress in developing policies that would help make the Treasury market more resilient, but there is still much work to be done.\u201d <\/p>\n Indeed, much of the progress touted in government speeches and reports on the topic is prospective in nature, including the proposal of policies that would enhance oversight and data collection of trading venues and dealers, studies on other policies like the promotion of \u201call to all\u201d trading whereby investors could directly trade Treasurys with each other, and a buyback program to be launched in 2024 that could help dealers offload older, less desirable government bonds.<\/p>\n Yadav said these proposals are welcome but insufficient \u201crelative to what\u2019s happening in the market, which is bearing enormous strains on a continuous basis.\u201d <\/p>\n In March 2020, investors around the globe began to understand the economic implications of the global coronavirus outbreak \u2014 declared a pandemic by the World Health Organization on March 11 of that year \u2014 and they panicked, selling whatever assets they could for cold, hard cash. <\/p>\n U.S. stocks cratered, with the Dow Jones Industrial Average Market Extra:<\/strong> Why the stock market might not bottom until investors surrender and jump back into bonds <\/p>\n \u201cThe trillion-dollar Treasury market, which is the foundation for all other financial trades, was lurching up and down in stomach-churning spasms,\u201d wrote financial historian Adam Tooze in his analysis of the COVID crisis. \u201cOn the terminal screens prices danced erratically. Or, even worse, there were no buyers at all.\u201d <\/p>\n The events of 2020 represented a culmination of several episodes of Treasury-market instability, including flash crashes in yields in 2014 and 2018 and stresses in the repo market for Treasurys in the fall of 2019. <\/p>\n It\u2019s these events that have motivated regulators to reform the structure of the market for U.S. Treasurys, which Yadav described as \u201cprofoundly unregulated in many ways\u201d even as it \u201cis expected to work when every other market doesn\u2019t.\u201d <\/p>\n The market for U.S. government debt has long been dominated by large banks The rise of electronic trading over the past 15 years has revolutionized the Treasury market, as high-frequency-trading companies deploying sophisticated algorithms have taken business from primary-dealer banks. <\/p>\n \u201cWhat high-frequency trading has done is create a lot more competition and change the incentives for primary dealers from protecting a profitable market to seeing it as a very competitive space\u201d that they will abandon if it becomes unprofitable, Yadav said. <\/p>\n \u201cOn numerous occasions, March 2020 included, dealers disappeared and high-frequency traders disappeared,\u201d she added. \u201cThis is becoming a very competitive space, and we have no understanding of how to address the instability arising from that competition.\u201d <\/p>\n Kevin McPartland, head of market structure and technology research at the data analytics company Coalition Greenwich, said in an interview that high-frequency-trading firms and other nonbank traders of government securities, like hedge funds, have stepped in to provide liquidity because traditional banks don\u2019t have the capacity. <\/p>\n That\u2019s in part because post-financial-crisis regulations have limited banks\u2019 ability to house risk on their balance sheets and in part because the size of the national debt has grown significantly. <\/p>\n \u201cThe upside is we have many more market participants providing liquidity in different ways and for different reasons than we had back then, and markets are much more efficient and electronic than they were 15 years ago,\u201d McPartland said. <\/p>\n But regulators don\u2019t have a clear view of the operations of this new breed of bond dealer, often unregistered with the Securities and Exchange Commission despite growing significance to the market. <\/p>\n The SEC, under Gary Gensler, has done more than any other regulator to push for bond-market reforms, proposing several rules last year that are still under consideration by the agency. <\/p>\n The first would require more securities companies to register with the government as Treasury dealers, while another seeks to require a larger share of government-bond trades to be centrally cleared. A third proposal would tighten requirements on electronic platforms traders use to submit bids and offers. <\/p>\n Other regulators, like the Fed and the Treasury, have been less aggressive, and there is little evidence that regulators are collaborating effectively to create a coherent plan for market-structure reform, Yadav said. <\/p>\n \u201cTreasury and the Financial Stability Oversight Council need to think about a total restructuring of the market,\u201d she said, referring to the group of regulators charged with monitoring the stability of the U.S. financial system. \u201cThat includes [a] plan for transparency and reporting, strains in dealer capacity and how to address problems in the repo market.\u201d <\/p>\n Market Extra:<\/strong> How Treasury market upheaval is rippling through global markets, in 4 charts<\/p>\n McPartland of Coalition Greenwich cautions against radical reforms to a Treasury market that has functioned well outside of a handful of crisis events, noting that the Monday after the failure of Silicon Valley Bank in March, the Treasury market traded $1.4 trillion in volume. <\/p>\n \u201cTo me,\u201d he said, \u201cthat\u2019s not a market with structural issues, when it can see that level of turnover in a tumultuous period.\u201d <\/p>\n The sheer amount of government debt that the Treasury must issue in the coming years, as deficits are projected to remain large by historical standards, is a potential variable that could challenge stability, he said. <\/p>\n \u201cWe\u2019re getting into a supply-and-demand problem,\u201d he said. \u201cSo far, so good, and people are liking the returns these bonds are providing today, but we don\u2019t know that will continue into perpetuity.\u201d <\/p>\n There is not much discussion on Capitol Hill or at the White House about a serious bipartisan plan for deficit reduction. President Joe Biden has proposed large increases in taxes on the highest-earning Americans and on corporations, while the Republican-led House of Representatives has been unable to coalesce around a plan, though the GOP generally favors reducing the deficit through spending cuts without tax increases.<\/p>\n\u2018Much work to be done\u2019<\/h2>\n
No buyers at all<\/h2>\n
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\n falling nearly 10% on March 12. Even more concerning was that the market for U.S. Treasurys, by some accounts, simply stopped functioning. The dash for cash was so great that it became difficult to find buyers for U.S. government debt, arguably the safest and most sought-after financial instrument in existence. <\/p>\nThe rise of the algos<\/h2>\n
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\n with special relationships with the U.S. Treasury and New York Fed. These so-called primary dealers are obligated to submit bids during Treasury auctions and are the New York Fed\u2019s trading counterparties as it buys and sells bonds to implement monetary policy. <\/p>\nCutting the deficit<\/h2>\n