The Resilience of the US Treasury Market

Abstract

The resilience of the world's most important security market is limited by its dealer-intermediated structure. Since 2007, the total size of primary dealer balance sheets per dollar of US Treasuries outstanding has shrunk by a factor of nearly four. This trend continues because of large US fiscal deficits and regulatory capital constraints, which are necessary for financial stability but reduce the flexibility of dealer balance sheets. Improvements in price transparency, trade protocols, central clearing, bank capital regulations, and Treasury buybacks can increase the intermediation capacity of the US Treasury market without necessarily sacrificing financial stability. Ultimately, the Fed can restore market liquidity by purchasing Treasuries, but this is a slow and costly last resort whose effectiveness can also be improved.