FEW THINGS BETTER KNOW BEFORE BUYBACK 5: Revisiting Treasury Buybacks

Treasury Borrowing Advisory Committee Discussion Charts p.67–91, 2022Q3.

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FEW THINGS BETTER KNOW BEFORE BUYBACK 4 : As a Tool of Debt Management

- Market Developments since 2015

• US Treasury Outstanding has doubled since 2015 and stands at historical highs. Going forward, debt to GDP is projected to grow steadily. The share of public debt held by the private sector will also have to increase because of Fed QT.

• Regulatory changes have reduced dealers’ intermediation capacity, including Supplementary Leverage Ratio (SLR), GSIB capital surcharges, SA-CCR Stress capital buffer and broad adoption of Basel III banking regulation standards globally. In addition to regulatory constraints, VAR constraints reduce risk appetite in moments of heighted volatility.

• Liquidity measures have worsened somewhat recently. The changes of these liquidity proxies could be related to changes in macroeconomic conditions but are likely to have been exacerbated by the market developments described previously.

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FEW THINGS BETTER KNOW BEFORE BUYBACK 2 : RMSE as treasury market liquidity measure

FEW THINGS BETTER KNOW BEFORE BUYBACK 1 : Measuring Treasury Market Depth by NY Fed

- Potential Benefits of Buybacks

• Experience of Fed asset purchase suggests that market liquidity benefited from regular purchases of less liquid off-the-run securities. Recent evidence suggests that better liquidity can lower the cost of funding- one narrow channel is that liquidity appears to be correlated with auction tails.

• Buybacks could potentially lower the cost of funding directly by purchasing cheaper securities while Treasury issues richer securities (for example: on the run vs off the run or bills vs old coupon). One concern is that greater buybacks coupled with greater issuance could erode the discount vs premium gap.

- Design: Key parameters and potential limitation

1. Size

Over time, buybacks would likely result in greater issuance. The size should be constrained as the reduction in on-the-run premia that would result in costlier issuance. $100–200bn per year could be meaningful in the context of the evolution of primary dealers inventories between 2018 and 2022.

2. Frequency

Flexibility on the timing and magnitude of purchases, but still need to fulfill Treasury long standing regular and predictable debt management strategy. Could be introduced via quarterly refunding along with existing tools. No matter how flexible it would be, the scope will be much more limited compared to Fed asset purchase, and it would not be intended to support market functioning in periods of acute market stress.

3. Composition

4. Market impact

5. Funding

Consider the relative pricing of auctions versus purchases, WAM (weighted-average maturity), and potentially complicating factor is the debt ceiling; for example, if there is a timing mismatch between greater issuance that precedes buybacks.

- Conclusion

The case for buybacks may have increased recently as debt outstanding has increased and market liquidity has deteriorated coincident with regulatory changes that have impacted dealers’ intermediation capacity. While Further study is warranted, especially on the size and frequency issue.

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