The endless pursuit of a well functioning Treasury market
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Since last November’s elections, the U.S. stock markets have been on a tear. The Dow Jones Industrial Average surpassed 20,000 for the first time in history a few weeks ago, and at the time of this writing, the index has seen gains of around 10 percent since the election. Analysts have opined that these movements are largely in response to anticipated pro-growth policies to be enacted under the Trump administration.

Meanwhile, the U.S. Treasury bond market, which funds the U.S. government and provides other critical functions to the global markets generally, has seen declines in prices and corresponding rises in yields. A variety of factors have contributed to these movements, including some of the same factors that are driving the equity market’s rise.

A recent Bloomberg story noted that from “Tokyo to Beijing and London, the consensus is clear: few overseas investors want to step into the $13.9 trillion U.S. Treasury market right now.” It cited the prospect of bigger deficits, more inflation, or higher interest rates from the Federal Reserve as possible explanations.

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Of course, we are still at the beginning of the 115th Congress and the new administration. It remains unclear whether new policies will align with the markets’ predictions. Certainly, a job-creating policy agenda is something all of us should be able to get behind. The fluctuations in the Treasury market are reminder, however, that care must continue to be devoted to ensuring that this market remains as healthy and as efficient as possible.

 

The Treasury market is enormous in size and scope and is essential to the global capital markets. It finances the U.S. government — including, of course, its infrastructure investments — and also serves as the baseline for determining global risk premiums. To put its size in context, the outstanding issuance of the U.S. Treasury market is close to two times the size of the U.S. equity market and 20 times the size of the U.S. corporate bond market. Its importance cannot be overstated.

Over the course of the last two years, policymakers at the Treasury Department, the Federal Reserve Board, the Federal Reserve Bank of New York, the Securities and Exchange Commission and the Commodity Futures Trading Commission have been analyzing the interplay between the Treasury market and other referencing markets, focusing on some of the events that led to the “flash crash” in the 10-year Treasury bond in late 2014 as well as the evolving structure of the market.

From a joint staff report issued in the summer of 2015, and from discussions at two conferences hosted by these same agencies entitled, “The Evolving Structure of the U.S. Treasury Market,” most recently taking place this past October, consensus has emerged on policy changes that are needed to effectively respond to market-structure changes.

One significant policy has already been adopted. Last fall, the Securities and Exchange Commission (SEC) approved the Financial Industry Regulatory Authority’s (FINRA) proposal to require its broker dealer members to report certain Treasury transactions to the TRACE reporting system. A compliance date has been set for July of this year. For the first time, regulators will receive routine post-trade reporting of this data, a noteworthy improvement that will allow more appropriate analysis and oversight by the regulatory community.

In addition to the need for greater regulatory transparency, the Treasury market also could benefit from the type of structural changes that were discussed at last October’s conference. In some respects, the market’s efficiency has improved by more efficient trading techniques resulting from new entrants deploying algorithmic trading strategies. In other respects, the overall market has become challenged because there are more venues to trade with these strategies, making it increasingly difficult to evaluate and effectively manage risk for aggregated trades in real-time and across markets.

At the same time, execution speeds often vary among venues, which can create imbalances in demand for Treasury securities and affect execution costs. Additionally, some trades are bilaterally cleared by the counterparty to the original trade, while others are cleared through a central counterparty. All of these factors cause fragmentation within the overall market and can reduce transparency.

At the conference last fall, there appeared to be agreement across a wide range of market participants in attendance that steps should be taken to address concerns related to fragmentation and transparency. Given some of the recent macro trends unfolding in the Treasury market, this need has become more urgent.

To be sure, the role of the federal government could take different forms in facilitating changes in market structure. Given the Treasury market’s importance to helping the U.S. government achieve its goals, leadership from the joint agencies that have responsibly led these important discussions is more important than ever. Congress can play a helpful role as well through thoughtful encouragement and oversight of these discussions.

Ongoing collaboration will be key to ensuring that the recent momentum behind realizing the needed changes to the Treasury market continues. The resiliency, stability and transparency of the market depends on it.

Mark Wetjen is a managing director and head of global public policy at the Depository Trust & Clearing Corporation. He was a member of the U.S. Commodity Futures Trading Commission under President Obama.


The views expressed by contributors are their own and are not the views of The Hill.