U.S. Treasury bonds plummet, banks "take over"?

Recently, U.S. Treasury bonds have plummeted, with the 30-year Treasury yield briefly surpassing 5% yesterday afternoon, and the 10-year Treasury yield again reaching the 4.5% mark.

The sharp decline in U.S. Treasury bonds has sparked expectations within the industry for government intervention to stabilize the market. However, banks are concerned that they will ultimately be the ones left holding the bag. On Tuesday, former BlackRock fund manager and veteran Wall Street investor Edward Dowd stated:

“Who will buy our Treasuries? It’s us… They plan to relax the SLR (Supplementary Leverage Ratio) regulations on Treasuries to allow banks to take them on.”

According to previous media reports, five Republican lawmakers in the U.S. have written to the Federal Reserve, calling for regulatory adjustments and urging the Fed to take action to improve liquidity issues in the Treasury market. They suggested considering “targeted” modifications to bank capital regulation, particularly concerning the SLR.

The SLR is part of the Basel III framework, which mandates that banks must reserve a certain percentage of capital for all their assets (including Treasuries) and cannot expand recklessly. If banks hoard too many Treasuries, capital requirements will rise significantly, leading banks to be reluctant to hold bonds and not actively trade, which affects market liquidity. For systemically important large banks, there are even stricter “enhanced SLR” requirements, exacerbating the issue.

The U.S. Treasury market is enormous, currently reaching $29 trillion. In recent years, this market has occasionally faced liquidity issues, such as during the early days of the pandemic in 2020 when the market became extremely tense, forcing the Fed to step in and purchase tens of billions of dollars in Treasuries daily to stabilize the situation.

Several investors and analysts believe that the liquidity crunch is related to the SLR framework. Some U.S. lawmakers are urging the Fed:

“We recommend that the Fed carefully assess whether targeted adjustments can be made.”

The Federal Reserve has not yet made an official statement. However, Powell mentioned last month during a congressional hearing that he supports lowering the SLR and stated:

“I do expect that we will return to this issue and work with new colleagues from other agencies to get this done.”