Who caused this week's "U.S. Treasury storm," "hedge funds, Japan, and even China"? Citigroup provides the real reason

This week, U.S. Treasury yields continued to rise, and the U.S. bond market experienced the most challenging liquidity event since the banking crisis in March 2023 and the pandemic in 2020.

On one hand, the two Treasury auctions since the beginning of the year have failed to achieve the expected success, leading to a significant increase in Treasury yields, and the reduction in hedge fund positions indicates growing market concerns about interest rates; on the other hand, weak demand from international markets and the risk of some countries potentially reducing their holdings of U.S. Treasuries have also left investors uneasy.

The Citigroup team led by Jabaz Mathai pointed out in a research report on the 11th that despite the sell-off in the Treasury market, the futures basis did not show significant signs of pressure. The decline in the real yields of TIPS was also greater than that of nominal yields. Between April 2 and April 9, foreign official holdings of U.S. Treasuries even increased by $3 billion.

This suggests that the market turmoil this week is more likely due to concerns over declining demand for U.S. Treasuries leading to a "buyer strike," rather than actual selling by foreign investors.

In 2023, the U.S. Treasury market experienced a "buyer strike," which was ultimately alleviated through a joint statement from the Treasury Department and the Federal Reserve. To avoid a similar situation from recurring, Citigroup proposed four potential solutions, including exempting the supplementary leverage ratio, halting quantitative tightening, adjusting the Treasury repurchase program, and eliminating the 20-year Treasury bond.

What Happened? Demand Shock and Market Turmoil, "Put Options" in the Bond Market

This week, the U.S. Treasury market experienced one of the most severe liquidity events since the banking crisis in March 2023. The auctions for the 3-year, 10-year, and 30-year Treasuries performed poorly, with the 10-year Treasury yield losing its hedging function and rising alongside the stock market's decline.

The poor performance of the 3-year Treasury auction on Tuesday triggered pressure on the 10-year Treasury auction on Wednesday, while the 30-year Treasury auction on Thursday also faced significant pressure.

Citigroup stated that the market's reaction to this turmoil is multifaceted. The swap spreads have significantly decreased, the yield curve has steepened notably, and the real yields of inflation-protected securities (TIPS) have also experienced substantial volatility.

Another notable phenomenon this week is that the Trump administration delayed the implementation of tariff policies. Citigroup believes that the government may be concerned that rising Treasury yields will increase interest expenses over the next decade, which is why some tariffs were postponed as Treasury yields approached 4.5%.

What is the Reason?

The market generally speculates that some countries may reduce their holdings of U.S. Treasuries due to U.S. tariff policies, but Citigroup, through analyzing data on foreign official holdings in the Federal Reserve's custody accounts, found that between April 2 and April 9, foreign official holdings of U.S. Treasuries increased by $3 billion, indicating that foreign investors may not have been selling U.S. Treasuries on a large scale

In addition, despite the sell-off in the government bond market, the futures basis has not shown significant signs of pressure.

“For example, the net basis of TY (10-year Treasury futures) has remained relatively stable amid this week's fluctuations, and compared to the significant volatility during the pandemic in 2020, the current basis level is relatively mild.”

This indicates that traders in the futures market are not overly panicking due to the sell-off in the government bond market, and the pricing mechanism in the futures market is still functioning normally.

Moreover, in this sell-off, the decline in the real yield of TIPS was greater than that of the nominal yield. Citigroup believes that this is not only due to increased market expectations of an economic slowdown but also because of a rise in liquidity premiums. This means that the market's adjustment of inflation expectations is not solely based on changes in economic fundamentals but also reflects concerns about market liquidity.

Therefore, Citigroup believes that the market turmoil this week is more likely due to concerns about declining demand for U.S. Treasuries leading to a "buyers' strike," rather than actual selling by foreign investors:

“This increases the likelihood that pure buyers are striking due to concerns about declining demand for back-end USTs, and it is likely driven by increased volatility in risk assets.”

So what can the U.S. do?

A buyers' strike refers to the phenomenon where investors refuse to purchase certain assets due to uncertainty about market prospects or policies. The buyers' strike in 2023 lasted for several months and was ultimately resolved through a joint statement from the Treasury and the Federal Reserve.

But what tools do the Federal Reserve and the Treasury have available now? Citigroup proposed the following possible solutions:

First, SLR (Supplementary Leverage Ratio) exemption, exempting Treasuries and reserves from SLR requirements may be the simplest solution, which would help enhance dealers' intermediation capacity, especially in the front-end market.

Second, halt QT (Quantitative Tightening), if QT is halted, the Federal Reserve would purchase about $15 billion of old Treasuries each month, which would help stabilize the market.

Third, adjust the Treasury repurchase program, the Treasury could introduce a "guaranteed" old Treasury repurchase program to address market turmoil.

Fourth, cancel the issuance of 20-year Treasuries, given the current supply-demand imbalance, canceling the issuance of 20-year Treasuries is reasonable and would help support the spread of long-term Treasuries