Why You Should Care About the Health of the US Treasury Market
I know very few people that have bought a US Treasury bond outside of their jobs as fixed income traders. No one logs onto their E*Trade account to buy or sell US Treasuries like they do AAPL stock. CNBC might mention the 10 Year yield, but that usually coincides with Rick Santelli ranting about bond vigilantes.
Even regulators are apathetic about the US Treasury market. In December 2014, Matt Leising of Bloomberg wrote how rules governing US Treasury trading that were enacted in ’86 and haven’t been updated since ‘98.
If you have a complaint about trading in the $12.3 trillion Treasury market, who are you going to call? That question is surprisingly hard to answer. While the U.S. Department of the Treasury and the Federal Reserve Bank of New York exercise some degree of oversight, there’s no one central authority charged with policing the market to prevent illegal trading activity in what is the world’s largest, most active bond market
Why are are regulators apathetic? My hunch is that US Government debt is (wrongly) seen as an institutional product that is traded by market professionals. If there is foul play or inefficiencies in the system, then it’s just a bunch of big boys beating each other up, and there is little spillover to retail investors or the rest of the economy.
Why does the differentiation between an institutional and retail investors matter? The history of financial regulations are almost always a reaction to how a previous crisis affected ordinary investors.
- Equities became heavily regulated through the Securities Acts of ’33 and ’34 following the ’29 crash in which brokers swindled clients through Ponzi schemes, inappropriate use of leverage, and outright theft.
- Futures and options trading was forced onto exchanges in response to the ’29 crash through the Commodity Exchange Act of ’36. Commodities brokers had used many of the same tactics as stock brokers to cheat the family farmers, who used futures to hedge their crops.
- Swaps (unfairly) received the lion share of the blame for the ’08 financial crisis, which led to a market crash affecting mom, pop, and their retirement savings. The Dodd-Frank Act, passed in reaction, now heavily regulates almost every aspect of trading swaps.
Mom and pop do not own a lot of US Treasuries outright, but the health of the market directly impacts them.
- If you have a pension, target date 401(k), or a bond mutual fund, then you do own US Treasuries through the fund. For example, the largest bond fund in the world, PIMCO Total Return, had 61% of their holdings in US Treasuries in December 2014.
- Retirees own a lot of municipal and corporate bonds. Municipal and corporate bonds are priced on a spread to US Treasuries. Why? Treasuries are treated as risk free, and the extra yield from munis/corporates is payment for the credit risk you take in owning the bond.
- The interest rate on your 30-year mortgage likewise is based on the yield of the 10 year Treasury note. There are almost $14 trillion of mortgages outstanding in the US, and all of them were originally priced on a spread to Treasuries.
- The Government runs a deficit and must sell debt to cover the difference. A dysfunctional market means that all American tax payers end up paying more to service this debt.
A healthy US Treasury market is important to more than just professional traders. The market impacts everyone that has a retirement account, buys a home with a mortgage, and/or pays taxes. In other words, just about everyone.
A lot of changed since the ‘90s: less than half of the primary dealers still exist, HFT firms have risen to become the dominant liquidity providers, and we no longer wear stone washed jeans. It’s time our regulations were updated to reflect the contemporary trading environment.
In the next couple weeks I’ll have a few posts on sensible reforms that could be enacted that would have a huge benefit to the entire US Treasury market: expanding TRACE, ending discriminatory pricing, and best execution for clients.
Thanks to Rachel for reading drafts of this.