MNI INTERVIEW: Reforms Aid Brittle Treasury Market-SEC Ghamami

The U.S. Treasury market remains vulnerable to bouts of illiquidity that could rattle financial markets, though reforms like increased central clearing should help alleviate more severe pressures, Securities and Exchange Commission economist Samim Ghamami told MNI.

“It is not unlikely to see at least mild illiquidity episodes in the Treasury market in the future,” Ghamami told MNI’s FedSpeak Podcast. “Liquidity in Treasury markets continues to remain low by historical norms, mostly due to high interest rate volatility.”

The SEC unveiled a new rule in December requiring central clearing in the Treasury market starting in two years, and that will help bolster liquidity, Ghamami said.

“If implemented effectively, it will bring more transparency in both the repo and cash part of secondary markets. Also, depending on the effectiveness of central counterparty risk management and margin rules, it may also reduce the buildup of leverage by the buyside in these markets,” he said.

QT PULLBACK

In the short-run, the Fed’s gradual retreat from QT will benefit Treasury liquidity. The central bank announced this week it was lowering the monthly cap for the runoff of Treasuries on its balance sheet to USD25 billion from USD60 billion, more than market participants had expected, starting in June.

“Slowing down the pace of QT could to some extent mitigate potential near-term illiquidity problems,” Ghamami said.

The Treasury also launched a buyback program as part of its May refunding announcement, which he said “will also be helpful.”

SUPPLY/DEMAND IMBALANCE

At its core, the lack of liquidity in what is supposed to be the world’s most liquid and stable bond market is due to a fundamental supply and demand imbalance, Ghamami said.

“We have more supply of U.S. Treasury securities and at the same time the size of the large, systemically important banks' balance sheets has not grown compared to the growth in the public debt,” he said.

“There are other layers as well. We know in the last several years so-called principal trading firms that carry out high frequency trading, electronic trading in the Treasury market, have also become very important players and liquidity providers.”

FINANCIAL RISKS

Ghamami, who also previously worked at the Treasury Department’s Office of Financial Research, said he’s still concerned about stability in regional banks after last year’s turmoil, particularly as rates look to stay higher for even longer.

Another source of concern for financial stability is private credit, Ghamami said, because the sector offers much less visibility for regulators trying to spot leverage in the system.

He also mentioned the increasing role of principal trading firms in the Treasury market as a potential source of turbulence.

“In general there has been a high buildup of leverage on the buy-side not just in the Treasury market but other parts of the financial system as well, and in a higher for longer market environment that could potentially have some adverse impact on the financial system,” he said.