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

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The U.S. Treasury Department on Friday said it plans to start talking with primary dealers in late October about the potential for it to begin buying back some of its older debt to help stave off market dysfunction.

The plan, if adopted, would mark a milestone in the roughly $22.6 trillion U.S. government debt market, the world’s largest, by providing a new tool for the Treasury to help aid market liquidity, a source of growing concern.

See: Treasury’s Yellen worried about ‘loss of adequate liquidity’ in U.S. government bond market

The proposal comes after the Bank of England was forced to step in with an emergency program to temporarily buy its government debt and to give U.K. pension funds more time to unwind soured bets. The volatility erupted as global central banks have worked to fight soaring inflation by ending easy-monetary policies that prevailed for much of the past decade.

Importantly, unlike in the U.K., the new Treasury proposal is separate from the Federal Reserve’s plans to sharply cut the size of its balance sheet by letting its holdings of Treasury and mortgage bonds roll off at maturity, a process known as “quantitative tightening,” (QT), after it hit a record size of nearly $9 trillion under two years of “quantitative easing,” (QE).

“This is not QE or QT. This is none of those,” said Thomas Simons, money market economist at Jefferies, in a phone interview. “This is the first, real serious beginning round of exploring if they might do something. This is quite far from an announcement. It is more like fact finding.”

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

How Treasury buybacks might work

The Treasury asked dealers for feedback by Monday, Oct. 24, about a new tool to buyback its off-the-run securities each year and if it would “meaningfully improve liquidity,” reduce volatility in T-bill issuance and help address other market concerns.

The idea would be to sop up “unwanted supply” of off-the-run securities that can become harder to trade once they are replaced with newer Treasury issuance, or on-the-run securities.

“It’s a supply management program, really, over the course of the year,” Simons said of the Treasury proposal. “It looks like a tool they could use over the long run and aim liquidity where it’s impaired.”

The Treasury has been meeting quarterly with the dealer community to solicit feedback on market functioning for years. Buybacks have been discussed at previous meetings in August 2022 and February 2015.

Is a U.K.-style debt crisis brewing in the U.S.?

The Federal Reserve began to pick up the pace of shrinking its balance sheet this fall, by letting more bonds it holds mature. It also no longer has been an active participant in the secondary market for Treasury securities, raising concerns about potential havoc and who might step up as an anchor buyer.

Read: The next financial crisis may already be brewing — but not where investors might expect

While the Fed’s holdings of Treasury securities would be considered off-the-run, the Treasury proposal “would have no relationship whatsoever to what the Fed has been doing” to shrink its balance sheet, Stephen Stanley, chief economist at Amherst Pierpoint Securities, told MarketWatch.

Recent volatility in the U.K. gilts market might have been a catalyst for the U.S. Treasury to put buybacks back on the agenda, Stanley said, but he also wasn’t alarmed by its reappearance as a topic of discussion.

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

Simons at Jefferies went a step further, arguing that if the Bank of England had a parallel, separate counterpart, like the U.S. Treasury Department, it might not have experienced such a “negative reaction by markets,” when it rolled out its temporary bond buying program at the same time it has been working to raise interest rates and otherwise tighten financial conditions to restrain inflation.

The benchmark 10-year Treasury yield
TMUBMUSD10Y,
4.016%

was near 4% on Friday, up sharply higher from its 2.3% closing low of the year, according to Dow Jones Market Data.

Sharply higher interest rates have shocked financial markets this year as the Fed has worked to tame inflation holding near a 40-year high. U.S. stocks were lower Friday, with the Dow Jones Industrial Average
DJIA,
-1.33%

off about 330 points, or 1.1%, and the S&P 500
SPX,
-2.35%

down 2% and the Nasdaq Composite Index
COMP,
-3.08%

2.6% lower.

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