Why the Treasury wants its bonds back

Stock buybacks are a standard element of market behavior, as companies consolidate ownership, stabilize stock prices or sweeten financial ratios. The business practice of reconsolidating debt is similar. But the U.S. government? With no shareholders to please and Washington’s penchant for fiscal spending, the U.S. Treasury would be the last place you’d expect to see the repurchase of anything, save perhaps a Susan B. Anthony coin.

But that’s exactly what is happening at the end of the month, we—and the liquidity industry in general—welcome it.

Along with its quarterly refunding announcement on May 1, the U.S. Treasury Department announced details for a buyback program for Treasury securities. This announcement was not a surprise to market participants, as the Treasury had introduced the potential for a buyback program almost a year ago. Many OECD countries have debt buyback programs, and it’s not a new concept for Treasury either. lt last did so from 2000–02, when the federal government was actually in a surplus position. The fiscal picture is very different today, though, so why is Treasury making this move now?

Over the past decade, federal government debt outstanding has essentially doubled, rising from $17. 5 trillion in 2014 to $34.6 trillion as of April 30. The Treasury market remains deep and liquid. But the growing debt burden, an evolving market structure, the impact of regulations, and episodes of deteriorating market functioning in recent years has focused attention on identifying ways to make it resilient. The buyback program is one way Treasury Secretary Janet Yellen will address these concerns.

Investors can buy U.S. securities through Treasury auctions, in what is known as primary issuance, and, of course, in the secondary market. The buyback plan targets the latter market, focusing on notes and bonds that have been outstanding for a while and are no longer the most recently issued security in a particular maturity range. These “off-the-run” Treasuries can trade with less liquidity than their current or “on-the-run” counterparts. By being a potential buyer of off-the-run securities, the Treasury Dept. will help to facilitate market making and provide liquidity support. These buybacks will start modestly, with Treasury offering to rehouse up to $2 billion in aggregate on a weekly basis across the Treasury yield curve. The plan should improve market functioning and liquidity during normal market environments. Officials have emphasized buybacks are not a tool to address periods of extreme market turmoil; that remains the purview of the Federal Reserve.

Treasury also plans on employing this process to aid its cash management, though it may not commence with these “cash management” buybacks for a while. The concept is to deploy an excess cash balance to buy back Treasury coupon-bearing securities with maturities between one month and two years. Treasury hopes this will mitigate the volatility in bill issuance that can occur when it reduces the magnitude of bill auctions because it is flush with cash, primarily on tax collection dates. These swings in bill issuance can be dramatic, and the new operations should diminish that arc and assuage market participants.

In recent years, the official sector has considered numerous proposals, and even enacted some, to enhance the resiliency of the Treasury market, with varying degrees of effectiveness. We think Treasury’s new approach has a good chance to succeed where others did not and make a positive contribution to the liquidity of this critical market.