Yesha Yadav on Treasury Market Turmoil and Potential Solutions for Reform

Episode Summary

Executive Summary: David Beckworth and Yesha Yadov discuss Treasury market fragility, CBDCs, and reform options. Yadov argues that Treasury liquidity strains reflect long-running structural weaknesses worsened by QT, higher rates, and reduced dealer balance-sheet capacity. She favors reforms like better clearing, transparency, SRF access, and especially affirmative market-maker obligations, while cautioning that buybacks and all-to-all trading are only partial fixes.

Main Topics: Treasury market fragility and current liquidity strains (Priority: 5/5): The conversation centers on worsening liquidity in U.S. Treasuries, with stress visible in market disruptions and widening gaps between prices and fair-value measures. Yadov emphasizes that these weaknesses are long-standing and are being exposed by today’s macro and regulatory environment. Structural causes: dealers, the Fed, and balance-sheet constraints (Priority: 5/5): Yadov argues that Treasury market dysfunction stems from shrinking willingness and capacity of primary dealers, the Fed’s QT and reduced buying, and diminished foreign demand. These institutional constraints leave the market more vulnerable during stress. Treasury buybacks and debt-management tools (Priority: 4/5): The hosts discuss Treasury buybacks as a potential way to swap illiquid off-the-run securities for more liquid issues. Yadov sees this as a temporary liquidity valve rather than a solution to the market’s underlying structural problems. CBDCs, governance, and privacy (Priority: 3/5): Before turning to Treasuries, Yadov updates her work on CBDCs, noting global experimentation and raising governance, privacy, and data-protection concerns. She suggests the U.S. is in a wait-and-see phase while other jurisdictions move ahead. Central clearing for Treasuries (Priority: 5/5): Yadov supports considering broader central clearing, but argues it mainly reduces counterparty risk rather than fixing liquidity shortages. She warns that a Treasury CCP could become a highly systemic institution requiring coordinated oversight across regulators. Transparency and all-to-all trading reform (Priority: 4/5): The discussion covers proposals to expand trade reporting and move toward all-to-all trading. Yadov sees benefits in better data and reduced dealer dependence, but cautions that too much transparency could fragment liquidity and that Treasuries are too special to simply mimic equities. Preferred reforms: market-maker obligations, SRF, and SLR adjustments (Priority: 5/5): Yadov’s preferred fix is affirmative market-maker obligations, backed by some balance-sheet relief and a more flexible standing repo facility. She also notes growing consensus that the supplemental leverage ratio should be refined to support Treasury intermediation.

Key Arguments: Treasury liquidity problems are not new; they are long-running structural fragilities exposed by stress events like March 2020 and the current high-rate environment. Primary dealers, high-frequency traders, and the Fed all supply less liquidity when stress rises, which is exactly when the market most needs them. QT and the Fed’s balance-sheet runoff matter because the Fed is both a large Treasury holder and an important backstop to market functioning. Global demand for U.S. Treasuries is weaker, with major holders such as Japan reducing purchases or selling, which raises pressure on domestic intermediaries. Treasury buybacks can improve market functioning by replacing older, less liquid securities with fresher ones, but they do not solve the market’s structural design flaws. Central clearing improves counterparty safety and may become essential if more diverse participants trade Treasuries, but it will not by itself cure liquidity disappearances. Greater transparency helps regulators understand market structure and systemic risk, but full transparency may be inappropriate for large block trades because Treasuries serve a special stabilizing role. All-to-all trading could broaden liquidity provision, but it may also fragment liquidity and requires robust clearing and additional safeguards. A Treasury market reform agenda should focus on ensuring that market makers remain active in stress, since Treasuries are supposed to function as a disaster-proof market. A more effective standing repo facility and targeted relief from leverage constraints could complement a market-making obligation. CBDC adoption in the U.S. depends heavily on governance, privacy protections, and public trust rather than technology alone.

Data Points: Countries experimenting with CBDCs: Around 90% - Yadov cites BIS survey results showing widespread international CBDC experimentation. Fed Treasury runoff: Around $80 billion per month - Yadov says the Fed is offloading Treasuries under quantitative tightening, adding pressure to liquidity. Japan’s Treasury holdings: $1.2 trillion - Japan is described as the largest foreign holder but currently less active as a buyer. U.S. marketable Treasury securities outstanding: Almost $24 trillion - Yadov notes the huge growth in supply of Treasury securities that must be absorbed by dealers and investors. 2007 Treasury supply: Around $6 trillion - Used to illustrate how much the Treasury market has expanded over time. Treasury market weekly trading volume: About $6 trillion a week - Yadov highlights the scale of the market when discussing systemic clearing risk. Treasury market daily volume: $627 billion a day in September - Illustrates the size and systemic importance of Treasury trading. Bilateral repo market size: About $4 trillion outstanding - Used to show the collateral and funding importance of Treasuries in repo. Repo market Treasury-backed share: About 68% - Yadov says most bilateral repo exposure is backed by Treasuries. Current Treasury clearing coverage: About 13% to 20% - She describes Treasury clearing as patchy and incomplete. Weighted average maturity of Treasuries: 74 months - Beckworth notes Treasury maturity has reached a record high, increasing off-the-run exposure.

Pivotal Quotes: "It’s an unbelievable time to be a law professor." — Yesha Yadov: She opens by describing how much there is to study in market microstructure, Treasury plumbing, bonds, crypto, and CBDCs. "The treasury market is facing its own helms deep." — Yesha Yadov: Her metaphor for the Treasury market’s multiple simultaneous stressors: dealer pullback, Fed constraints, and weak foreign demand. "Treasuries are the most special security in our entire marketplace." — Yesha Yadov: She explains why reform ideas from equity markets cannot simply be transplanted into Treasury markets.

Implications: Treasury reform will likely be incremental, not a single fix. The episode suggests policymakers should prioritize market-making resilience, leverage relief, and better plumbing oversight to protect the financial system’s core safe asset.