When Selling Treasuries Is Difficult, There Is Another Route to Cash

A conference focused on Treasury-market liquidity

The 12th annual U.S. Treasury Market Conference took place on September 22. It focused on liquidity-related issues, including the deployment of Treasury cash into repo markets, central clearing, and short-term financing. Those topics raise a question: if an institution holding Treasuries urgently needs cash, does it necessarily have to sell its bonds?

Treasury buybacks add another buyer

On the 9th of this month, the Treasury had already increased the size of its long-end buyback operations, allowing market participants to sell older, less liquid bonds back to it. Strong demand from participants in long-dated securities was the reason for increasing the scale of those operations.

But Treasury buybacks simply add another buyer. They suit institutions that want to sell their bonds outright. If an institution intends to retain its holdings and only needs cash temporarily, that tool is of limited use.

Borrowing against Treasuries instead of selling them

Selling Treasuries is a direct way to obtain cash, but transaction costs rise when many holders sell at once. There is another option: use the bonds as collateral to obtain cash, without an outright sale.

Repo financing is straightforward. An institution hands over bonds in exchange for cash and agrees to repurchase them the next day. The extra amount paid at repurchase is the interest on the financing.

Repo is still market-based financing between institutions, however. If many institutions need cash simultaneously, rates in this channel will rise and counterparties will become more cautious and selective. At that point, the central bank's collateralised lending channels can provide support.

Central-bank funding cushions help avoid forced sales

Depository institutions can borrow cash from the Fed through the discount window against eligible collateral. When cash becomes scarce in the market, eligible counterparties can also use standing repo operations, providing Treasuries to the New York Fed in exchange for overnight cash. The rate on this facility is 4.00%.

A Fed speech described the discount window as a buffer during periods of market stress. Institutions can pledge Treasuries and obtain loans on the same day, without selling their bonds in the market, reducing the risk of forced sales. When the Treasury market became disorderly in March 2020, the volume of Treasuries pledged by institutions rose sharply.

This differs from Treasury buybacks. Buybacks provide an additional buyer, allowing institutions to raise cash by selling bonds. The Fed's two tools instead help holders obtain cash without an outright sale of their bonds.

Why several layers of liquidity protection are needed

Treasuries are core collateral in the global financial system. A concentrated wave of selling can quickly reduce market depth, amplify price fluctuations, push yields higher, and tighten financing conditions more broadly.

The value of these collateralised funding arrangements lies in directing some demand for cash towards borrowing against securities, so that pressure is not concentrated entirely in bond sales.

Orderly markets are the ultimate objective

Treasury creditworthiness concerns whether obligations can be paid at maturity. Liquidity mechanisms address whether institutions have no option but to sell bonds when they urgently need cash. The two mechanisms operate differently, but share an objective: keeping the Treasury market functioning smoothly.