[House Hearing, 119 Congress]
[From the U.S. Government Publishing Office]
EXAMINING TREASURY MARKET FRAGILITIES AND PREVENTATIVE SOLUTIONS
=======================================================================
HEARING
before the
TASK FORCE ON MONETARY POLICY, TREASURY
MARKET RESILIENCE, AND ECONOMIC PROSPERITY
of the
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED NINETEENTH CONGRESS
FIRST SESSION
__________
MAY 15, 2025
__________
Serial No. 119-24
Printed for the use of the Committee on Financial Services
[GRAPHIC(S) NOT AVAILANLE IN TIFF FORMAT
www.govinfo.gov
U.S. GOVERNMENT PUBLISHING OFFICE
60-576PDF WASHINGTON : 2025
HOUSE COMMITTEE ON FINANCIAL SERVICES
FRENCH HILL, Arkansas, Chairman
BILL HUIZENGA, Michigan, Vice MAXINE WATERS, California, Ranking
Chairman Member
FRANK D. LUCAS, Oklahoma SYLVIA R. GARCIA, Texas, Vice
PETE SESSIONS, Texas Ranking Member
ANN WAGNER, Missouri NYDIA M. VELAZQUEZ, New York
ANDY BARR, Kentucky BRAD SHERMAN, California
ROGER WILLIAMS, Texas GREGORY W. MEEKS, New York
TOM EMMER, Minnesota DAVID SCOTT, Georgia
BARRY LOUDERMILK, Georgia STEPHEN F. LYNCH, Massachusetts
WARREN DAVIDSON, Ohio AL GREEN, Texas
JOHN W. ROSE, Tennessee EMANUEL CLEAVER, Missouri
BRYAN STEIL, Wisconsin JAMES A. HIMES, Connecticut
WILLIAM R. TIMMONS, IV, South BILL FOSTER, Illinois
Carolina JOYCE BEATTY, Ohio
MARLIN STUTZMAN, Indiana JUAN VARGAS, California
RALPH NORMAN, South Carolina JOSH GOTTHEIMER, New Jersey
DANIEL MEUSER, Pennsylvania VICENTE GONZALEZ, Texas
YOUNG KIM, California SEAN CASTEN, Illinois
BYRON DONALDS, Florida AYANNA PRESSLEY, Massachusetts
ANDREW R. GARBARINO, New York RASHIDA TLAIB, Michigan
SCOTT FITZGERALD, Wisconsin RITCHIE TORRES, New York
MIKE FLOOD, Nebraska NIKEMA WILLIAMS, Georgia
MICHAEL LAWLER, New York BRITTANY PETTERSEN, Colorado
MONICA DE LA CRUZ, Texas CLEO FIELDS, Louisiana
ANDREW OGLES, Tennessee JANELLE BYNUM, Oregon
ZACHARY NUNN, Iowa SAM LICCARDO, California
LISA McCLAIN, Michigan
MARIA SALAZAR, Florida
TROY DOWNING, Montana
MIKE HARIDOPOLOS, Florida
TIM MOORE, North Carolina
Ben Johnson, Staff Director
------
TASK FORCE ON MONETARY POLICY, TREASURY MARKET RESILIENCE, AND ECONOMIC
PROSPERITY
FRANK D. LUCAS, Oklahoma, Chairman
BILL HUIZENGA, Michigan JUAN VARGAS, California, Ranking
ANDY BARR, Kentucky Member
MARLIN STUTZMAN, Indiana BRAD SHERMAN, California
SCOTT FITZGERALD, Wisconsin JOSH GOTTHEIMER, New Jersey
MIKE FLOOD, Nebraska SEAN CASTEN, Illinois
MONICA DE LA CRUZ, Texas CLEO FIELDS, Louisiana
TROY DOWNING, Montana JANELLE BYNUM, Oregon
C O N T E N T S
----------
Thursday, May 15, 2025
OPENING STATEMENTS
Page
Hon. Frank D. Lucas, Chairman of the Task Force on Monetary
Policy, Treasury Market Resilience, and Economic Prosperity, a
U.S. Representative from Oklahoma.............................. 1
Hon. Juan Vargas, Ranking Member of the Task Force on Monetary
Policy, Treasury Market Resilience, and Economic Prosperity, a
U.S. Representative from California............................ 2
STATEMENTS
Hon. French Hill, Chairman of the Committee on Financial
Services, a U.S. Representative from Arkansas.................. 4
WITNESSES
Mr. Nathaniel Wuerffel, Head of Product and Global Market
Structure, Bank of New York (BNY).............................. 4
Prepared Statement........................................... 7
Mr. Darrell Duffie, PH.D., Adams Distinguished Professor of
Management and Professor of Finance at the Graduate School of
Business, and Professor by Courtesy, Department of Economics,
Stanford University............................................ 18
Prepared Statement........................................... 20
Mr. Ira Jersey, Chief U.S. Interest Rate Strategist and Global
Rates Team Leader, Bloomberg Intelligence...................... 29
Prepared Statement........................................... 31
Ms. Jill Cetina, Executive Professor of Finance, Mays Business
School, Texas A&M University................................... 46
Prepared Statement........................................... 48
APPENDIX
METERIALS SUBMITTED FOR THE RECORD
Hon. Frank D. Lucas:
Bank Policy Institute (BPI).................................. 82
Depository Trust & Clearing Corporation (DTCC) and Fixed
Income Clearing Corporation ( FICC)........................ 98
Independent Dealer and Trader Association (IDTA)............. 99
RESPONSES TO QUESTIONS FOR THE RECORD
Written responses to questions for the record from Representative
Maxine Waters
Mr. Nathaniel Wuerffel....................................... 102
Mr. Darrell Duffie........................................... 103
Mr. Ira Jersey............................................... 104
Written responses to questions for the record from Representative
Monica De La Cruz
Mr. Nathaniel Wuerffel....................................... 105
EXAMINING TREASURY MARKET FRAGILITIES AND PREVENTATIVE SOLUTIONS
----------
Thursday, May 15, 2025
U.S. House of Representatives,
Task Force on Monetary Policy,
Treasury Market Resilience, and
Economic Prosperity,
Committee on Financial Services,
Washington, DC.
The Task Force met, pursuant to notice, at 10:02 a.m., 2128
Rayburn House Office Building, Hon. Frank Lucas [Chairman of
the Task Force] presiding.
Present: Representatives Lucas, Hill, Huizenga, Barr,
Stutzman, Fitzgerald, Flood, De La Cruz, Downing, Vargas,
Sherman, Casten, and Bynum.
Chairman Lucas. The Task Force on Monetary Policy, Treasury
Market Resilience, and Economic Prosperity will come to order.
Without objection, the chair is authorized to declare a recess
of the committee at any time.
Without objection, all members will have 5 legislative days
within which to submit extemporaneous material to the chair for
inclusion in the record.
I would now like to recognize myself for 4 minutes for an
opening statement.
OPENING STATEMENT OF HON. FRANK D. LUCAS, CHAIRMAN OF THE TASK
FORCE ON MONETARY POLICY, TREASURY MARKET RESILIENCE, AND
ECONOMIC PROSPERITY, A U.S. REPRESENTATIVE FROM OKLAHOMA
This hearing is entitled ``Examining Treasury Market
Fragilities and Preventative Solutions.'' Today, we will take a
30,000-foot view of Treasury market structure with a particular
focus on the market under stress. We will endeavor to use last
month's volatility as a case study in current market conditions
and functioning and examine what changes may have been helpful
in improving the resilience of the market. We cannot overstate
the importance of this topic. A highly liquid and resilient
Treasury market is fundamental to the global economy.
There have been a number of episodes in recent years that
have made us remember the enormous privilege we have of being
the world's global reserve currency and boast safe haven asset
status. Last month was one of those moments. We observed almost
every measure of liquidity in the Treasury market decline
rapidly over a 3-day period.
Thankfully, the market is resilient and recovered quickly
from the stress of the broader macroeconomic uncertainty but
challenges like last month remind us that we must safeguard our
most important asset, our deep, liquid, healthy, sovereign debt
market. We can bolster the resilience of the market by learning
lessons from market stress we observed in 2014, 2019, 2020, and
a few weeks ago. My, it seems relevant, does not it, when you
think about that?
For example, in 2023, the Securities Exchange Commission
(SEC) voted to mandate central clearing for cash transactions
and repurchase agreements involving Treasurys. This is a
fundamental shift and a massive undertaking by market
participants. I have been working with the SEC to ensure that
firms have appropriate time to come into compliance. Similarly,
we need to get implementation right. There are outstanding
questions that need to be addressed, and Chairman Atkins is
well-positioned with broad stakeholder feedback to clarify the
rule's execution.
I have also repeatedly urged the prudential regulators to
exempt Treasurys and reserves from the supplemental leverage
ratio and the enhanced supplemental leverage ratio due to their
low-risk nature. We should incentivize participation in the
market, not make it cost prohibitive.
The Treasury market has doubled in size since I was on the
Dodd-Frank Conference Committee. We should reconsider some of
the provisions enacted that may have had adverse consequences
and that disincentivize participation in financing our debt. In
the last decade, we have seen dramatic changes in buyers of
Treasurys. Some of this is positive. Innovation is driving
demand. On the other hand, we should look carefully at what is
causing some investors to leave the market. Our debt
instruments need to retain their attractiveness to a broad
array of participants.
I want to make it clear, there is no silver bullet here.
The Treasury market will always be sensitive to macroeconomic
challenges, but there are changes we can consider to improve
this resilience. I hope to work with my colleagues on both
sides of the aisle to address these constraints.
With that, I yield back.
The chair now recognizes the ranking member of the
subcommittee, Mr. Vargas, for 4 minutes for an opening
statement.
OPENING STATEMENT OF HON. JUAN VARGAS, RANKING MEMBER OF THE
TASK FORCE ON MONETARY POLICY, TREASURY MARKET RESILIENCE, AND
ECONOMIC PROSPERITY, A U.S. REPRESENTATIVE FROM CALIFORNIA
Mr. Vargas. Thank you very much, Mr. Chairman, and thank
you for forming such an excellent panel and I want to thank the
witnesses for being here today. Thank you to each and every one
of you.
A resilient and liquid Treasury market is critical not only
to the functioning of our own capital markets but also to the
functioning of markets around the world. The Treasury market
plays a key role in the Federal Reserve System (Fed)
implementing its monetary policy, provides the benchmark risk-
free rate for pricing other assets, and finances our government
at a low cost to the taxpayers.
Last month, when the Treasury market experienced volatility
in the wake of President Trump's liberation date, it was no
surprise that many expressed alarm about the financial
consequences surrounding the tariffs. We saw the 10-year yield
jump more than 50 basis points, which represented the largest
3-day jump since 2001.
As this administration continues to publish policy edicts
through Truth Social, a number of analysts have signaled
concern that the market volatility is here to stay. Even though
we did see relatively strong demand in the Treasury's auctions
of 10-year and 30-year bonds following the initial movement in
the market, all this uncertainty makes maintaining resiliency
all the more important.
Growing uncertainty is not the only reason it is pivotal to
shore up the strength of our Treasury market. The growth in
existing Treasury market debt has brought new attention to the
issue of resilience, and this growth is on track to continue.
In fact, the nonpartisan Congressional Budget Office has
predicted that the U.S.' national debt held by the public over
the next 10 years will grow from $30 trillion to $52 trillion,
incredible numbers.
They also found that extending President Trump's tax cut
for the next 10 years would add $4.6 trillion to our national
debt. Let us not forget that for all the talk about my
colleagues on the other side of the aisle about the need for
government efficiency and fiscal conservatism, the last
President to balance a budget and produce a surplus was a
Democrat, President Bill Clinton. As the government issues more
debt, it will need investors willing to buy it and it is
important that dealers continue to have the ability to buy and
sell this new debt. So in order to have a strong Treasury
market, we also need to evaluate whether dealers maintain the
capacity they need to intermediate.
Given all these challenges, it is critical that we keep
taking steps toward improving the resiliency of the Treasury
market. That is one of the reasons why I have been glad to see
that our financial regulators have undertaken several reforms
aimed just at that. For instance, I am hopeful that the final
rule requiring the central clearing of eligible transactions
will, as former SEC Chair Gensler said, ``Help to make the
Treasury market more efficient, competitive, and resilient.''
In order for that to happen, though, it is essential that the
market participants and regulators continue to work together to
implement it.
We have also seen steady progress on the increased data,
transparency, and availability within the Treasury market.
Financial Industry Regulatory Authority's (FINRA's) decision to
move from publishing weekly aggregate volume transaction data
to publishing daily aggregate volume transaction data was a
step in the right direction. I look forward to continue to
explore other ways to ensure that our Treasury market remains
resilient for the foreseeable future.
With that, Mr. Chairman, I again thank you, and I yield
back.
Chairman Lucas. I thank the gentleman, and I appreciate his
compliment about my being in the majority for that 3 1/2 years
of surplus. With that, the chair now recognizes the gentleman
from the full committee, Chairman Hill, for 1 minute.
STATEMENT OF HON. FRENCH HILL, CHAIRMAN OF THE COMMITTEE ON
FINANCIAL SERVICES, A U.S. REPRESENTATIVE FROM ARKANSAS
Chairman Hill. Thank you, Chairman Lucas.
Today's hearing will explore the recent volatility in the
Treasury markets and potential regulatory changes to mitigate
future risk and ensure liquidity. While we all witnessed the
disruption in the Treasury market last month, the bond market
can sometimes react sharply to sudden policy changes,
irrespective of whether those policies come from former
President Obama, former President and current President Trump,
or even the Fed itself.
The Treasury market is the world's largest and most liquid
government bond market, and given its global and domestic
importance, it is paramount that it remains resilient as
possible during times of volatility. In all markets, volatility
is probable and inevitable, and thus policymakers must push for
policies that ensure that the markets remain liquid and orderly
with the goal of preventing or mitigating future episodes of
volatility.
I look forward to these excellent panelists' views on
recent Treasury market events and continue our policy
conversation to ensure our U.S. Treasury market resiliency.
Thank you, Mr. Chairman. I yield back.
Chairman Lucas. Thank you, Mr. Chairman.
Today, we welcome the testimony of Mr. Nathaniel Wuerffel,
Head of Product, Global Collateral, and Head of Market
Structure at Bank of New York (BNY); Dr. Darrell Duffie, Adams
Distinguished Professor of Management and Professor of Finance,
Graduate School of Business and Professor by Courtesy,
Department of Economics, Stanford University; Mr. Ira Jersey,
Chief U.S. Interest Rate Strategist and Global Rates Team
Leader, Bloomberg Intelligence; Ms. Jill Cetina, Executive
Professor of Finance, Mays Business School, Texas A&M
University.
We want to thank each of you for taking time to be here,
and each of you will be recognized for 5 minutes to give an
oral presentation of your testimony. Without objection, your
written statements will be made a part of the record.
Mr. Wuerffel, you are now recognized for 5 minutes.
STATEMENT OF MR. NATHANIEL WUERFFEL, HEAD OF PRODUCT AND GLOBAL
MARKET STRUCTURE, BANK OF NEW YORK
Mr. Wuerffel. Good morning, Chairman Lucas, Ranking Member
Vargas, and members of the Task Force. Thank you for the
opportunity to testify on the importance of U.S. Treasury
market resilience. My name is Nate Wuerffel, and I am the head
of market structure and the head of product for the Global
Collateral Platform, which supports financing of Treasury
securities at BNY.
Prior to joining BNY, I spent 25 years at the Federal
Reserve. In my last role, I ran the Domestic Markets Trading
Desk, carrying out large-scale trading operations, intelligence
gathering, and financial market analysis for the Federal Open
Market Committee and the U.S. Treasury Department, among other
stakeholders.
BNY was founded by Alexander Hamilton 240 years ago and has
a long and interconnected history with the U.S. Treasury market
ever since. We have become a global financial services company
that helps make money work for the world by managing it, moving
it, and keeping it safe. Our founder negotiated the first loan
to the U.S. Government from the Bank of New York. Shortly
thereafter, as the first Treasury Secretary, he laid out his
vision for how the country would address the Nation's debt.
It was rooted in two core attributes, safety and liquidity.
Government bonds would be safe because they would be backed in
full by the U.S. Government on their original terms and liquid
because they would be easily converted to cash at a fair market
price by any holder. It proved to be a resounding success. We
are proud of the role we continue to play supporting the U.S.
Treasury market, including as the primary settlement provider,
among other activities.
The Treasury market plays an important role in the lives of
everyday Americans. It serves as a benchmark for borrowing
rates for everything from mortgages to auto and consumer loans.
At $29 trillion outstanding, the Treasury market has grown.
Over the last decade, the market has experienced several
episodes of dysfunction, including in 2014, 2019, and following
the coronavirus disease (COVID-19)ndemic.
Most recently, the events that took place in April tested
market functioning. They prompted investors to question the
resilience of the market in the face of policy uncertainty and
the potential impact on the future direction of growth,
inflation, interest rates, and the supply of Treasury debt. The
events serve as a reminder that the safety and liquidity of the
Treasury market are essential to its continued functioning.
Given the critical role of the Treasury market, over the
last decade, both the public and the private sectors have
stepped up work to improve the resilience of the market. One of
the most consequential of these efforts is the SEC's central
clearing rule, which should enhance financial stability by
improving the willingness of market participants to continue
trading in the Treasury market, even in times of stress. The
Treasury clearing rule is only one of several public and
private sector solutions that are important to strengthen the
safety and liquidity of the Treasury market.
I would highlight three priorities. First, timely
completion of the central clearing rule would reduce
counterparty credit risk and improve financial stability.
Implementation should provide a level playing field for all
market participants, be limited to Treasury security
transactions and not inadvertently capture non-Treasury trades,
continue the current industry and regulatory momentum to
promote smooth implementation, and avoid delays that lead to
excessive transition costs, and result in consistent margin
practices across the ecosystem.
Second, a targeted adjustment to leverage ratios for cash
and Treasury securities can support the ability of banks to
hold cash reserves and intermediate in the Treasury market. The
leverage ratio was intended to be a backstop but today
constrains banks from supporting Treasury market
intermediation, particularly in times of stress. A narrow
adjustment would be a more effective means of supporting
Treasury market intermediation than alternatives such as
lowering the overall ratio, which might result in increased
activity and riskier assets.
Third, faster, more reliable and more efficient ways to
exchange Treasury securities for cash are essential to support
market liquidity. This includes discount window modernization,
making it easier to move Treasury securities across public and
private liquidity pools, and options for early and intraday
repo.
BNY commends the committee for its work examining the
resilience of the Treasury market, and we look forward to
working with you to support a safe and liquid Treasury market.
I am happy to answer any questions you may have.
[Prepared statement of Mr. Wuerffel follows:]
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Chairman Lucas. Thank you.
Dr. Duffie, I may have spent too much time in
reconciliation markups in the last 10 days. You are now
recognized for 5 minutes for your oral remarks.
STATEMENT OF MR. DARRELL DUFFIE, PH.D., ADAMS DISTINGUISHED
PROFESSOR OF MANAGEMENT AND PROFESSOR OF FINANCE AT THE
GRADUATE SCHOOL OF BUSINESS, AND PROFESSOR BY COURTESY,
DEPARTMENT OF ECONOMICS, STANFORD UNIVERSITY
Mr. Duffie. Thank you, Chairman Lucas, and thank you for
inviting me to testify today.
Weaknesses in the structure and regulation of the Treasury
market raise the cost to American taxpayers for funding the
government. These weaknesses also risk financial stability and
effective monetary policy. For U.S. Treasurys to remain the
world's premier safe haven asset and the anchor of dollar
dominance, the intermediation capacity of the Treasury market
must be greatly expanded.
Although, as you said, Chairman Lucas, there is no silver
bullet for this, regulators could consider the following
policies. One, fix the capital regulation known as the
supplementary leverage ratio, or SLR. Two, encourage the
emergence of all-to-all trade in the Treasury market. Three,
transparently separate the Federal Reserve's purchases of
Treasurys that support crisis market functioning from the Fed's
other asset purchases. Four, make further use of the Treasury
Department's buyback program. To my understanding, Chairman
Lucas, Treasury market regulators have sufficient authorities
from Congress to address these policies.
When COVID-19 became a global pandemic in March 2020, the
Treasury market became dysfunctional because bond dealer
balance sheets could not handle the surge of investor sales of
Treasurys. Last month, tariff policy shocks threatened a
similar crisis. Until concerns about the resilience of the
Treasury market are addressed, bond investors who anticipate a
need to raise cash quickly in a future crisis will reduce their
everyday reliance on U.S. Treasurys. The cost to American
taxpayers will rise correspondingly.
The SLR reduces the incentives of banks to buy safe assets.
Reserves, Treasury repos, and short-term securities have very
low risk but require the same SLR capital buffer as a risky
real estate loan. The prices of long-term Treasurys, however,
are volatile in a crisis and are not risk-free from the
perspective of a bond dealer. If regulators do reduce the SLR
for safe assets, the resulting reduction in bank capital should
be offset with other changes in capital requirements.
The best capitalized dealers are those most able to provide
liquidity to the Treasury market, especially during a crisis.
Investors should be enabled to trade Treasurys not only with
dealers but also directly with each other on all-to-all
platforms. This would increase market capacity and resilience.
It is notable that all-to-all Treasury futures markets
maintained functionality even through the COVID shocks of March
2020.
Incentives for the emergence of all-to-all trade are
improved by more central clearing, more post-trade price
transparency, and eliminating the market practice known as
done-with trading, by which investors who clear transactions
through a given dealer are required to also trade with that
same dealer. Regulators should push further in all three of
these directions.
Fed purchases of Treasurys to support market functioning
will probably be necessary in some future crises but could act
at cross-purposes with monetary policy or could even be
confused with fiscal actions. The Fed should clearly
distinguish its market function purchases from quantitative
easing. Market resilience would also be enhanced if the Fed's
Treasury market trades are settled at clearinghouses.
In some future crises, the Treasury Department could play
its own liquidity backstop role by using its ability to buy
back Treasurys. When Treasury Secretary Bessent was asked last
month about tariff-related stresses in the Treasury market, he
said, ``We have a big toolkit that we can roll out. We could up
the buybacks.'' I agree with that.
In conclusion, while already planned improvements in
Treasury market regulation, especially expanded central
clearing, as Mr. Wuerffel said, are helping, these are not
nearly enough. The capacity of the Treasury market should be
significantly expanded. Treasury market regulators are well-
positioned to achieve this. Thank you.
[Prepared statement of Mr. Duffie follows:]
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Chairman Lucas. Thank you.
Mr. Jersey, you are now recognized for 5 minutes for your
oral remarks.
STATEMENT OF MR. IRA JERSEY, CHIEF U.S. INTEREST RATE
STRATEGIST AND GLOBAL RATES TEAM LEADER, BLOOMBERG INTELLIGENCE
Mr. Jersey. Chairman Lucas, Ranking Member Vargas, and
members of the Task Force, thank you for the opportunity to
appear today. I am Ira Jersey. I serve as the chief U.S.
Interest Rate Strategist for Bloomberg Intelligence, a research
arm of Bloomberg LP. These views are mine alone and not
necessarily those of Bloomberg or any of its employees.
While the Treasury market remains the most liquid bond
market in the world, that liquidity can sometimes be an
illusion. We have repeatedly seen that in periods of stress or
volatility, market depth can quickly vanish. This is not new. I
warned of this fragility well over a decade ago, and recent
episodes continue to underscore the challenges to liquidity in
the world's most important market. I believe the root cause of
these liquidity issues are structural and not easily rectified.
Since the 2007 to 2009 global financial crisis, we have
adopted regulations rightly aimed at ensuring a safer and
fairer financial system, but they have come at a cost. Balance
sheet constraints have reduced the capacity of market makers to
provide liquidity during times of stress. Put differently, we
traded a more resilient financial system for less resilient
markets.
This trade may be acceptable in principle, but we must be
honest about its consequences. Also, the amount of Treasury
securities outstanding also matters to market function. Market
intermediaries such as dealers and banks do not have enough
balance sheet flexibility to efficiently make markets in times
of stress while also complying with all of these requirements.
Many of the often-suggested fixes will be helpful to market
function but none are sufficient to prevent bouts of
volatility. Central clearing of Treasurys and repurchase
agreements, for example, will help prevent market dysfunction,
but functioning markets do not prevent prices from moving
sharply. One promising tool has been the sponsored repo market,
which allows more efficient funding of Treasury positions.
Use of sponsored repo has grown to about $2 trillion,
representing a substantial amount of repo trades tied to
Treasury transactions but sponsored repo growth has recently
stalled due to counterparty limits and delayed implementation
of central clearing. Exempting Treasurys from the supplementary
leverage ratio can also be helpful to liquidity generally, but
it is not a silver bullet.
Other regulatory constraints, like liquidity coverage ratio
and the net stable funding ratio, continue to limit how much
risk banks and dealers can take and absorb, especially during
volatile periods. Together, these rules discourage expanding
balance sheets just when the market needs those balance sheets
most.
The market structure has also changed. High-frequency
trading firms now account for a large share of activity, but
they tend to pull back during periods of volatility. High-
frequency trading firms contribute to the illusion of liquidity
where the market seems deep until it suddenly is not.
Additionally, we need to be cautious about how we interpret
recent volatility. Some worry that the use of leveraged basis
trades involving Treasury futures and cash bonds has increased
instability, but there is little evidence of a large-scale
unwind. Futures open interest remains steady, repo markets are
functioning, and money markets have not fled to the Fed's RRP
facility. Basis trades fears seem to be overstated.
Finally, we must recognize that demand for global Treasurys
is ever-changing. Private foreign investors now hold more long-
term U.S. debt than official institutions like central banks
and sovereign wealth funds. That means more market risk is
concentrated in hands that are sensitive to returns and hedging
costs, not necessarily government policy mandates.
Another major shift in the past decade is domestic buyers
having supplanted foreigners as the major purchaser of
Treasurys, even following the end of the Federal Reserve's
asset purchase program. Ultimately, the decision to purchase a
Treasury security is one of economics. Does owning a Treasury
at a specific yield meet the need of an investment mandate?
Does it fulfill a regulatory requirement? Is it at a market
price where I think I can sell it for a profit or at least not
a loss? These are just a sample of why Treasurys are purchased,
but ultimately, it comes down to price. During periods of
uncertainty or one-way trading, prices will move to meet
demand.
In closing, improving Treasury market resilience requires a
comprehensive coordinated approach. There is no single fix that
will change this issue. Volatility regularly occurs even within
highly functioning markets, but there are always ways to make
the market more elastic, such as allowing targeted regulatory
flexibility during times of stress so that dealers can step in
when they are needed most. That would give us a safety valve
without compromising long-term financial stability.
Thank you. I look forward to continuing this discussion.
Prepared statement of Mr. Jersey follows:]
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Chairman Lucas. Thank you.
Ms. Cetina, you are now recognized for 5 minutes for your
oral remarks, please.
STATEMENT OF MS. JILL CETINA, EXECUTIVE PROFESSOR OF FINANCE,
MAYS BUSINESS SCHOOL, TEXAS A&M UNIVERSITY
Ms. Cetina. Thank you. Good morning. I will begin by
discussing three drivers of higher Treasury volatility after
the April tariff announcement.
First, inflation expectations rose around the tariff
announcement. For instance, the 1-year zero-coupon consumer
price index (CPI) swap rose from about 2.3 percent in October
to 3.6 percent after the tariff news. Treasury volatility
increased because higher inflation expectations triggered a
paradigm shift for some investment portfolio management. The
common 60-40 equity bond portfolio begins to break down as a
strategy when expected inflation exceeds 3 percent, replaced by
alternative strategies that do not favor Treasurys.
Second, hedge funds have been trading the swap cash basis
since the election. Simply put, hedge funds expect Treasurys
will be excluded from banks' supplementary leverage ratios.
Hedge funds expected banks to buy more Treasurys and that the
spread between secured overnight financing rate (SOFR) swaps
and comparable maturity Treasurys would rise. The unwind of
this trade contributed to Treasury volatility as well.
Finally, the dollar weakened, and this is important because
the dollar typically strengthens in risk-off events. Dollar
weakness was suggestive of foreign capital outflows from the
United States. Recent data from Japan indicates Japanese
private and official holdings of Treasurys declined by about
$20 billion in early April.
Developments such as the sharp appreciation of the Taiwan
dollar is also notable. These data suggest that Asian investors
are rethinking their unhedged dollar exposures and perhaps
dollar asset allocations more broadly and imply upward pressure
on yields in U.S. fixed income markets will continue. Thus, the
increase in Treasury market volatility on the one hand
reflected investors' surprise to tariffs. On the other, these
developments also reflect decades of economic policy undertaken
with minimal consideration about their longer-run impact. These
policies were enabled by trends such as disinflation from
globalization, labor force growth, and low yields due to
unconventional monetary policy. Trends that have been
extrapolated that they will continue forever.
However, these forces are now in retreat, even as we face
the problem that U.S. Government debt has simply grown too
large. History suggests that high government debt is often
solved through inflation, diminishing debt in real terms, but
also eroding the currency's purchasing power. Movements in gold
against the dollar over the last 2 years are close to meeting
the IMF staff's definition of a currency crisis. Treasury
market fragility and erosion of the U.S. dollar status are
interlinked.
What then should or should not be done, and here I will
differ from my colleagues. First, proposals for bank capital
regulation are, in my view, a risky solution to Treasury market
fragility. Eliminating bank capital requirements for U.S.
Treasurys when Treasurys are exhibiting heightened price
volatility is inconsistent with sound risk management. Also,
U.S. banks continue to have about $500 billion in unrealized
securities losses as of today. A prolonged bear steepening move
in Treasurys is a plausible risk scenario that could have an
even more negative impact on banks if Treasurys become SLR-
exempt.
After World War II, U.S. Government debt to Gross Domestic
Product (GDP) was roughly 100 percent. About 50 percent of U.S.
banking system assets were invested in Treasurys at that time,
and these positions did not require capital. So, maybe we
should do this again. Simply put, we are not living in the
1950s. In the 1950s, Regulation Q prohibited U.S. banks from
paying interest on checking accounts, so about 75 percent of
bank funding had zero interest cost. Given interest rate
deregulation in the 1980s due to the growth of money market
mutual funds, banks must now compete for deposits, so today, it
is impossible for banks to safely fund lots of long-dated
government debt. If anything, high bank exposures to long-dated
Treasurys combined with the absence of quantitative regulation
and weak supervision of interest rate risk means that a sharp
rise in Treasury yields can threaten bank solvency. This was
the essence of Silicon Valley Bank.
Second, the Federal Reserve's use of unconventional
monetary policy has both contributed to unsound fiscal policy
and been destabilizing to the banking sector. For this reason,
I do not support proposals to exclude banks' reserve balances
at the Fed from the leverage ratio. Let us be clear that doing
so permanently would remove all constraints on the size of the
Fed's balance sheet.
Finally, we need to use the right tool. That is stabilizing
fiscal policy, bringing the deficit down. I thank the committee
for the opportunity to speak.
[Prepared statement of Ms. Cetina follows:]
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Chairman Lucas. Thank you.
We will now turn to member questions, and the chair
recognizes himself for 5 minutes for questioning.
Mr. Jersey, and then I would like to get Mr. Wuerffel's
thoughts on this also, can you describe the functioning of the
market during the high volatility last month? How were markets
able to accommodate both high volume with low liquidity?
Mr. Jersey. The answer is it did function. The market price
moved in order to find where demand met--what was met. In a
period, for example, overnight, if we look at April 7th in
particular, where Asian investors came in after hearing some
news overnight, decided to sell Treasury securities, but at
that point, remember, there is a very limited pool of liquidity
during those hours, right, so some of the volatility was more
from a timing issue. If you just look at how volatile the
market was during that 2-hour period from 10 p.m. our time to
midnight, once you got to 1 when Frankfurt opened and Paris
opened and London opened, ultimately, you had a bigger pool of
liquidity, and prices rebounded somewhat because you were able
to find another pool of liquidity.
The challenge we have looking at the Treasury market on a
daily basis in a market that basically does not close is that
you have to appreciate when those market moves occur, and is
that really a clearing price during that moment, or is that
overall clearing price for the entire global market? I think
that we experienced that during those 3 or 4 days in April.
Chairman Lucas. Mr. Wuerffel.
Mr. Wuerffel. Thank you for the question. In April, what I
think we saw was that there was uncertainty around trade
policy, and that led into uncertainty about some fundamental
factors that drive interest rates in the Treasury market,
including the path of interest rates, the inflation, the growth
of the Treasury market and its supply.
What we see in the Treasury market, it is the safest, most
liquid market in the world. It trades about $1 trillion a day
in purchase and sale activity and about $5.5 trillion dollars
of repo financing activity a day, so it is able to withstand
high degrees of volatility. What we saw in April, that the
indicators of market functioning, things like bid-ask spreads
and other indicators, did deteriorate rapidly. However, they
recovered after some of the uncertainty was resolved. I think
what I see in April is that it is sort of a cautionary tale, a
reminder that we need to focus on the safety and liquidity of
the structure of the Treasury market to make it resilient going
forward.
Chairman Lucas. Continuing with you, Mr. Wuerffel, you have
testified that the SEC's clearing rule could improve market
liquidity and resilience. Can you talk about the importance of
getting implementation right, not just done? We only realize
the benefits of a rule like this if all the regulators are
rolling in the same direction, would you not say?
Mr. Wuerffel. That is an excellent question, and I would
agree that the central clearing rule represents the most
significant change to Treasury market structure in decades. We
think it is important because it will reduce counterparty
credit risk and financial stability risk, but getting it right
is paramount. The extension of the timelines that the SEC
announced recently have been helpful.
I think the market will be able to use that additional time
to implement the changes, the necessary operations and legal
documents. We think a fair and level playing field
implementation of central clearing is important, and that is
achievable, we think, in the timeframes given.
Chairman Lucas. Dr. Duffie, last week I spoke with
Secretary Bessent on these issues, and he testified that recent
auctions had weaker investor demand. He suggested capital
requirements may be playing a role there. What are the
regulatory constraints on market participants' balance sheets
and should regulators look at recalibrating the SLR and the
enhanced supplementary leverage ratio (ESLR) to encourage
intermediation in the Treasury market?
Mr. Duffie. Chairman Lucas, I agree with Secretary Bessent
that capital plays a role. However, well-capitalized dealers
are best positioned to bid aggressively in the auction, so
capital constraints matter, but lowering capital altogether is
not a good idea. The distortionary effects of the SLR, on the
other hand, should be corrected. There is no reason to
penalize, for example, Federal Reserve deposits because of any
sort of risk or illiquidity. On the contrary, they are
perfectly liquid. So improving the SLR but making sure that
banks remain very well capitalized should be the priority both
for Treasury market resilience and also for financial stability
generally.
Chairman Lucas. The fundamental challenge, I think, is
this: The market's ability to intermediate is not commensurate
with the tremendous growth in the issuances many of you have
touched on. We have to come up with a way to address that
intermediate capacity moving forward.
With that, my time is about to expire. The chair recognizes
the Ranking Member of the Task Force, Mr. Vargas, for 5 minutes
of questions.
Mr. Vargas. Thank you very much, Mr. Chairman. Again, I
want to thank the panel for being here.
Ms. Cetina, you heard the comments that were made by Mr.
Wuerffel regarding the central clearing rule. Do you have any
comments to what he said, any disagreements?
Ms. Cetina. No. I think central clearing is foundationally
important and can be helpful to promoting greater stability in
the Treasury market and getting to better controls around
counterparty credit risk. I do think it is important that
central clearing of Treasurys be implemented, but if there is a
need for a bit more, I will say, runway to make that be an
effective rollout, that is sensible. I think what would be
unfortunate is if somehow that were to just not happen, which I
do not perceive was Mr. Wuerffel's position.
Mr. Vargas. Okay. So there does seem to be some agreement
there then?
Ms. Cetina. Yes.
Mr. Vargas. Any disagreement between any of the rest of
the----
Mr. Jersey. No, I wholeheartedly agree. In fact, if we go
back to the 2007 to 2009 financial crisis, if we had central
clearing of things like credit derivatives at the time, which
we do now, the volatility probably would have been most
mitigated very significantly. Central clearing, I think, is a
way to have a public good and be able to mutualize the risk of
the clearing of the market, and especially Treasurys, because
they do not have credit risk, so they should be something that
we should be able to easily clear.
Mr. Vargas. Dr. Duffie.
Mr. Duffie. I completely agree. Increasing central clearing
should remain one of the highest priorities of Treasury market
regulators. It is crucial for Treasury market resilience and
for financial stability.
Mr. Vargas. Okay. Now, I do want to ask now because Mr.
Jersey, you said this, the amount of Treasurys outstanding was
an issue. In fact, assume that today the national debt is
$36,215,000,000,000, and it is going up every moment.
If my Republican friends are able to pass the ``big,
beautiful bill,'' will that number next year be higher or
lower? Will it be more than $36 trillion or less than $36
trillion?
Mr. Jersey. I think, ultimately, in order to cut our
deficit forecast----
Mr. Vargas. That number?
Mr. Jersey. Our deficit forecast is for $1.8 trillion
deficit this year and next year, so----
Mr. Vargas. Even if they pass their bill?
Mr. Jersey. Correct.
Mr. Vargas. Ms. Cetina, do you agree with that?
Ms. Cetina. I am sorry. I do not have a particular
forecast, but my understanding is that we are looking at
deficits widening under what is being discussed currently in
this chamber of Congress and that would increase financing
needs. So, again, going back to my fundamental position, which
is that we need to do more to bring the deficit under control.
I think that this is the root cause of the issues that we are
discussing in this committee today, which is the fact that we
have not brought the budget deficit onto a glidepath down.
Mr. Vargas. In fact, could you talk a little bit about the
problem of stagflation? If we get into stagflation because of
the increase in our debt and the situation that we will find
ourselves in if this ``big, beautiful bill'' passes, and
tariffs and all the other chaos that we see.
Ms. Cetina. I would like to make the point that
stagflation, to me--the risks that it poses to the U.S. banking
sector, I think, perhaps may be underappreciated. The reason
that I say this is that stagflation activates credit problems
at banks, liquidity risk, and interest rate risk all
simultaneously. We have not experienced this in the U.S.
banking sector since the 1980s. So any bank that is even trying
to make I will call it a strong effort to model what this might
mean, a macroeconomic scenario like this for themselves, faces
significant data limitations and challenges. So I do think this
is a very challenging environment that banks may face.
The reason that I am raising this in response to your
question is that banking crises, the median banking crisis,
according to International Monetary Fund (IMF) research, adds
about 34 percentage points in terms of debt to GDP when they
occur. So from my vantage point, avoiding a banking crisis is
highly important to not seeing the Treasury market size expand
massively because of a financial stability event, and it is
something that I think----
Mr. Vargas. I have just 15 seconds left. I would just say
that, again, if we are going to tame the deficit and the debt,
we cannot continue down this, giving huge tax cuts to wealthy
people. It just is not going to work.
Thank you. With that, I yield back.
Chairman Lucas. The gentleman yields back.
The chair now turns to the gentleman from Arkansas, Mr.
Hill, chairman of the full committee, to be recognized for 5
minutes. Mr. Chairman.
Chairman Hill. Thank you, Mr. Lucas. We are all concerned
about the long-term unsustainable budget deficits, 7 percent of
GDP. Let us be clear, the crisis of 9/11, the financial crisis
of 1907 to 1909, and the pandemic produced extraordinary
reactions from the U.S. Government spending, period, full stop,
paid for by borrowing money to fund those crises.
It is a bipartisan issue and to treat it in a partisan way
does not make any difference to this hearing because the fact
of the matter is we have that situation. If it was such a
crisis, then perhaps President Biden and then-Speaker Nancy
Pelosi would not have authorized $6 trillion of new spending on
top of a $2 trillion deficit that we were running anyway due to
those crises.
Let me start with you, Dr. Cetina. I really enjoyed your
testimony. Very, very interesting. Comment one, I took your
point about you are not a quantitative easing (QE) fan from
your background. I am not either. I thought it was a big
mistake by previous Feds. Should we pay interest on reserves of
the Fed?
Ms. Cetina. I think that to do so is basically equivalent
to taxing the banking sector. It becomes a ``heads, you lose;
tails, you lose'' proposition for the banking sector if we do
not pay any interest. The reason that I say that is that when
policy rates were at zero, this was a drag on banking sector
performance. Then if when rates are higher, we also do not pay
interest, it is a drag on banking sector performance.
I do believe--and I have published research when I was
associate managing director at Moody's, it was the first piece
of research I published when I joined Moody's, that
unconventional monetary policy is credit-negative for U.S.
banks. I really think this needs more discussion. Viral Acharya
and others have published on this.
Chairman Hill. It is where monetary policy links with our
discussion today, and it is why Chairman Lucas and Ranking
Member Vargas have such an important task. I think to sort
through that is one of the top issues.
On central clearing, I see a lot of unanimity on that point
today and I think we have seen the benefits in the past, and we
see it now in the Treasury market. Is central clearing 7 days a
week, 24 hours a day, Mr. Wuerffel?
Mr. Wuerffel. Thank you for the question. Central clearing
is not 7 days a week, 24 hours a day.
Chairman Hill. Should it be?
Mr. Wuerffel. I----
Chairman Hill. The biggest, most liquid market in the
world, generating $2 trillion of new issuance every year?
Mr. Wuerffel. I think one of the really interesting things
about the Treasury market is its evolution over time and moving
into a world where you can settle a Treasury security, you can
get cash for a Treasury security in smaller increments of time
anywhere in the world at any time of day would be a real
advancement in the Treasury market. I think there is a lot of
operational and mechanical steps that are needed to get to that
state.
Chairman Hill. Dr. Duffie, you talked about expanding
capacity in the market. That is, again, a theme of this Task
Force. What does that mean to you? How do you see expanding
capacity in the Treasury market?
Mr. Duffie. Thank you, Mr. Hill. On a normal day, the
Treasury market deserves the label of being the deepest and
most liquid market in the world. It has plenty of capacity. It
is really the surge capacity that is in question. In March 2020
and to a lesser extent, last month, we saw that when investors
around the world suddenly want to sell a lot of Treasurys, and
volatility is very high, the capacity of the market is
stressed. It is exactly at those moments that investors who had
been holding Treasurys in order to use them in a stressed
market are having difficulty selling them.
To me, increasing the capacity means increasing the peak or
surge capacity of the market by expanding the ability of
dealers to absorb customer positions, and if necessary, by
trading through all-to-all platforms where you do not
necessarily have to take up space on a dealer balance sheet.
Chairman Hill. Yes, that is helpful. Thanks for that.
Should the Fed have a Treasury-only balance sheet, ideally?
Mr. Duffie. That is my view. That reduces----
Chairman Hill. Does the panel share that view? You have
worked at the Fed. Jill, what is your view on that?
I am talking about long term, like not in a period of
crisis where they might choose another asset class. Should it
be Treasurys in the long run, though?
Ms. Cetina. My concern is that the Fed is so large that
when the Fed disfavors agency MBS, it creates potentially
richness in the agency MBS market that may actually draw
private investors into agency MBS and away from Treasurys. The
Fed is not a small actor in the bond market. It likes to
pretend that it is, but that is not the case.
Chairman Hill. Thank you. I yield back. I appreciate the
chairman's time.
Chairman Lucas. The gentleman yields back.
The chair now recognizes the gentleman from California, Mr.
Sherman, who is also a Ranking Member of the Subcommittee on
Capital Markets, for 5 minutes.
Mr. Sherman. We take some solace that we have been here
with this large of a debt right after World War II, but we
should not because that debt could be paid off without
increasing taxes or decreasing domestic spending because we
ended World War II, and we brought the boys home. So we have
never faced a crisis like this. We have a national debt that
would embarrass Argentina. We have gotten away with it for a
long time, but now, we are reaching points that even the United
States may not be able to handle. We have to deal with the size
of the debt, the fact that crypto has said that it wants to
take some or all of the benefits of being the world's reserve
currency away from us.
We have to deal with the insanity of our current President.
Liberation Day, no Liberation Day, chaos is costly. We have to
deal with the effect of inflation, and of course the Peterson
Institute said that Trump's policies would increase inflation
over the next several years by 4 to 7 1/2 points. We have to
deal with the international effect of the lack of the rule of
law, increasing obvious corruption and the attacks on the Fed,
all of which undermine the image of the United States and the
dollar.
We are paying an awful lot. The debt compounds on itself
because we have to pay interest on the debt, which is now going
to be the largest thing we spend money on, or we monetize the
debt. I think we ought to be looking more at that, not because
it is a solution, but because it may be less painful than
paying interest on the debt.
The chair of the full committee pointed out that we had $6
trillion of COVID spending. I should remind him that 70 percent
of that was signed by Donald Trump, whereas I do not know a
Democrat who voted for the 2017 tax cut, and I do not know a
Democrat that is going to vote for the tax cuts they are
considering now.
I want to thank Ms. Cetina for pointing out the importance
of interest rate risk to our banks. That is what doomed Silicon
Valley Bank, and the idea of treating a long-term instrument,
Federal or otherwise, as risk-free ignores the fact that
interest rates can go up and down.
Let us see. Believe it or not, I do have some questions in
here somewhere. Okay. Three years ago, I was able to pass the
LIBOR Act, which dealt with $16 trillion of adjustable rate
instruments, where, had we not passed that act, the debtor and
creditor would not know how much was to be paid because the
index was no longer published.
Mr. Wuerffel, we have now changed from LIBOR to SOFR. How's
that going?
Mr. Wuerffel. Thank you for the question. I think the
transition away from LIBOR has been a significant success. That
is after many years of work, and I spent many years working on
this problem at the Federal Reserve. We have seen a quite
smooth transition away. That took a lot of work to make sure
that the markets could successfully implement the change and
then come out of it functioning smoothly.
I think it is perhaps a useful parallel to some of the
opportunities that the public sector has to support market
change in the Treasury market, where adjustments to improve
market safety like central clearing or targeted adjustments to
the leverage ratio to improve intermediation or the ability to
promote more liquidity in the market could be useful.
Mr. Sherman. I want to squeeze in one more question. We
have a supplemental leverage ratio, which is the key factor in
banks determining their policies, and it seems to discriminate
against U.S. Treasurys by regarding them as no more risk-free
than bonds issued by private players in the market. The
leverage capital requirements are insensitive to the fact that
the Treasurys are risk-free as far as credit risk.
Mr. Wuerffel, could you talk us through what happens in the
broader financial markets if U.S. Treasury markets become less
liquid, perhaps as a result of the large banks feeling that
they cannot hold U.S. Treasurys in the quantities they are used
to?
Mr. Wuerffel. Thank you for that question. The Treasury
market is the safest, most liquid market in the world, and it
really hinges on those two characteristics of a Treasury
market. These are those foundational characteristics all the
way back to Alexander Hamilton. It is a safe instrument to
conduct a trade in, and you are guaranteed the payment by the
government. It is also a liquid instrument because it can
change hands.
So, I think if you undermine either of those
characteristics of a Treasury security, you have a risk of
undermining confidence in it as an asset class. It is a huge
asset to the United States as a country and to taxpayers that
we have this market that allows us to finance the government at
low cost.
Chairman Lucas. The gentleman's time has expired.
The chair now recognizes the gentleman from Michigan, Mr.
Huizenga, who is also vice chairman of the full committee, for
5 minutes.
Mr. Huizenga. Thank you, Mr. Chairman. I appreciate your
time and everybody being here today. This is incredibly
important that we examine this.
Dr. Duffie, let me start with you if I could, please. You
had mentioned this, I think, very briefly, the all-to-all
trading in an answer to Chair Hill, and you talked about the
emergence of this and how they are improved by greater use of
central clearing, as we have talked about pretty extensively,
and more post-trade transparency. You noted that regulators
should push further in these directions.
You did say in your testimony, encouraged--and I think in
parentheses ``although not mandate.'' So, I am curious as to
the word choice and definition on that, first of all. Can you
help the committee understand how you believe this can be
accomplished? Do you believe investors will get better
execution, increased competition by having more of this
information?
Mr. Duffie. Yes, Mr. Huizenga. It can be accomplished by
some of the measures that I discussed in my testimony like more
central clearing, more price transparency, and eliminating some
practices that make it difficult for investors to trade with
competition among different counterparties. By introducing all-
to-all trade, investors can compete with each other for the
opportunity to buy and to sell. They do not need to rely
exclusively on a dealer to do that. They do not need to impinge
on a dealer balance sheet to execute a trade. Markets will
become more liquid because of improved competition and market
capacity.
How is that more transparent, though? It is more
transparent in part because exchange trading or all-to-all
trade provides more immediate price transparency and more
information on market depth.
Mr. Huizenga. All right. Will there be greater
efficiencies, more liquidity? I mean, we talked about
transparency, but is there going to be efficiencies or
liquidity added if this is adopted?
Mr. Duffie. Yes, definitely. Just as we see today in the
futures market where we did not have problems with this
functionality, you get greater efficiency because you have more
investors that can trade directly and immediately with each
other, not necessarily having to go through a dealer's balance
sheet and waiting for the dealer to then on-sell the Treasurys
to another investor.
That is not to say that dealers would not be part of the
all-to-all trade. They would be the most important contributor,
and many investors would still want to trade directly with the
dealer.
Mr. Huizenga. These would not be in any kind of dark pool.
It would be out--would there be some, again--with the central
clearing, I assume that is how this would have that gained
transparency?
Mr. Duffie. That would be the ideal, but of course it would
be up to regulators how to design the infrastructure and the
regulations around that. As you mentioned, I do not think
regulators should mandate that. An overly prescriptive
regulation that forces all-to-all trade could have unintended
consequences.
Mr. Huizenga. Okay. Last week, Roberto Perli, who manages
the Fed's roughly $6 billion securities portfolio, said that
one factor that contributed to the sharp rise in yields was due
to the abrupt unwinding of the swap spread trade, a trade that
both Mr. Jersey and Mr. Wuerffel had highlighted in their
testimonies. Mr. Jersey, could you briefly explain what the
swap spread trade is and its role in April's volatility?
Mr. Jersey. Sure. First, let me say that one of the reasons
why Treasury securities are so liquid, even though there is a
large amount outstanding, is that we have an entire
infrastructure of derivative instruments that investors and
dealers and others can use to hedge them, and swaps and
interest rate swaps are just one of them.
Interest rate swaps right now are based on SOFR, on the
secured overnight financing rate, and investors, when they get
into a swap spread trade and the trades that unwound a little
bit in early April were long Treasury securities in the
anticipation that the SLR would be amended to exclude
Treasurys, so people purchased Treasury securities and they
paid or sold interest rate risk via swaps. When there was some
doubt as to what the extent of the SLR would be or those
shifts, you saw an unwind of those trades.
To market function standpoint--and since we are talking
about market function today, I would note that the repo market
and other funding sources and other funding parts of those
trades all functioned very smoothly, even though there was very
significant movement in the price of both of those instruments,
both Treasurys and interest rate swaps.
Mr. Huizenga. I am out of time, but I was going to ask
could the SLR reforms have prevented or mitigated the impact of
the Treasury markets that stem from the unwinding of the swap
spread trade? I am out of time. We will submit that question
for writing, though, because I think that would be----
Chairman Lucas. The gentleman's time has expired.
The gentleman from Illinois, Mr. Casten is recognized for 5
minutes.
Mr. Casten. Thank you, Mr. Lucas. Thanks to our witnesses.
As my colleagues know, I spend a lot of time thinking about
climate change and trying to deal with it here. My sort of
long-term concern is that our challenge dealing with climate
change in this country is not because the physics is not
understood, it is because it has become political to
acknowledge the physics. So, the rest of the world looks at the
United States and says when Democrats are in, you will deal
with this, but when Republicans are in, you will not, and so we
cannot treat the United States as a reliable partner.
My fear in this hearing is that we are at a point where
monetary policy is falling into that same bucket of things that
should not be partisan but are. We have a naked emperor who has
fallen in love with 1890s fiscal policy. Let us jack up
tariffs, let us go to hard money, let us have light touch
regulation. We know from the 1890s that leads to 1890s style
panics, but we cannot talk about that. We can just talk about
how nice the emperor's clothes are.
Now we are finding ourselves with this scenario, and I
think, Ms. Cetina, you mentioned, it has been an unprecedented
month, as all you know. We had a collapse in U.S. equity
markets, stapled to a collapse in Treasurys. That is not
supposed to happen.
I guess I would like to start with you, Mr. Wuerffel,
because last month, BNY Mellon said, ``The haven status of
Treasury securities is increasingly in question,'' as foreign
investors have been selling more Treasurys. Is that still
ongoing? How concerned are you that is a structural trend going
on in our market right now?
Mr. Wuerffel. Thank you for that question. If you look at
some of the longer-term trends, what we see in the Treasury
market, for example, in the last decade, is that foreign
holdings of the Treasury market have gone down as a share of
the Treasury market size from about 50 to 30 percent over that
10-year period. Then we also see ebbs and flows in foreign
participation in the Treasury market, and we did see some
flows.
Mr. Casten. I just challenge that because like over the--I
agree with those 10-year trends----
Mr. Wuerffel. Yes.
Mr. Casten [continuing]. but we also saw foreigners like
the Japanese, like the Europeans, move from investing in the
U.S. economy via Treasurys to investing in the U.S. economy via
equities. I do not think we have a 10-year trend of people
selling off equities and getting out of Treasurys, right?
Mr. Wuerffel. Yes, what I would say, in the Treasury
market, as you have said, you have seen a change in the
composition of Treasury market ownership, but just as some
players have pulled a smaller share, other players--for
example, money funds, mutual funds--have grown their share of
the Treasury market. I think the important thing is making sure
it is a marketplace with a broad and deep buyer base----
Mr. Casten. Look, I understand what you are saying. You are
also making me only more scared because, from your perspective,
you do not want to annoy these folks over on the other side of
the aisle by acknowledging what we know to be true. Bridgewater
just said that foreign investors are placing a risk premium on
U.S. assets, and there is a ``slow bleed'' of support out of
U.S. markets, not just Treasurys.
Bank of America, as you mentioned, Ms. Cetina, saw a $8.9
billion outflow into Japanese and European stocks at the end of
April. If you had perfect foresight, you would have moved your
portfolio into European equities on January 20th, and yet on
January 19th, everybody was saying that the U.S. economy was
the envy of the world, right?
So, I guess, Professor Cetina, can you help us understand,
if we have this exit from Treasurys, that is going to lead to
higher Treasury rates, right? It is going to lead to a weakened
dollar, which means a more expensive cost for us to pay off our
debt, and ultimately, some long-term threat to the reserve
currency of the U.S. dollar. How many of those changes are
fixed once you put someone economically literate who is not
beholden to Peter Navarro in the White House, and how many of
those changes are irreversible?
Ms. Cetina. I guess how I would respond to this question is
that I think we have foreign investment that is quite broad in
U.S. financial markets, and I think it is very important that
U.S. economic policymakers on both sides of the aisle recognize
that we have what is called the net international investment
position of the United States, which is the accumulation of
foreign portfolio investment, which is the counterpart to our
trade deficit, which amounts to almost 80 percent of U.S. GDP.
So, we need to pay attention, for lack of a better word, to
our relationships with other countries, how we communicate with
them. This is very important. There are less important
investors in Treasury markets but important investors in our
investment-grade corporate bond market, in the equity market,
as you pointed out. To the extent that they decide that they
want to hedge dollar holdings more, hold fewer dollar holdings,
then basically I think what we are looking at is, in general
equilibrium, higher costs of capital for the United States.
Mr. Casten. I could talk much more, but I am out of time.
Thank you, and I yield back.
Chairman Lucas. The gentleman yields back.
The gentleman from Kentucky, Mr. Barr, who is also Chairman
of the Subcommittee on Financial Institutions, is now
recognized for 5 minutes.
Mr. Barr. Thank you, Mr. Chairman. I suppose we could talk
about fiscal sustainability in the context of the Laffer curve
and whether or not a massive tax increase on the American
people would stifle economic growth to the point where it would
worsen, not help our deficit and debt picture.
I am going to resist the temptation to launch into that
debate, but let me just ask any of you all, based on Professor
Cetina's point about the importance of fiscal responsibility,
sustainability of our debt picture, I want to know what the
tipping point is. Can any of you help the committee understand
what is the tipping point? So we have a $36 trillion national
debt. That is 127 percent of our GDP. There are other
countries, a few handful of countries with higher debt-to-GDP
ratios. Japan comes to mind, 250 percent, among the highest in
the world. When do the bond vigilantes come? Does anybody have
an opinion about that, where people start demanding much higher
yield because it is a riskier asset? It is the safest, deepest
liquid market in the world, but when does that cease to be? Can
anyone offer an opinion on that?
Mr. Jersey. So, Congressman, I have spent quite a lot of
hours studying this exact issue, trying to find that number,
that magic number of percent of GDP or however else you want to
couch it, but our opinion within our strategy group at
Bloomberg Intelligence is we are very close to that level
where, not that you will just see a massive sell-off in
Treasurys, but that Treasury sell-offs will become somewhat
more pronounced and rallies will be shallower.
So, the Treasury market at this point--and I think given
the fact that we are the reserve currency, we do have a very
broad ownership base and buyer base and reasons for people to
own it, will continue to be cyclical with interest rates or
with the economy, but they are not just going to randomly sell
off to, say, 10 percent. We are not an emerging market. Until
the reserve currency changes to something else, the U.S.
Treasury market, I think, will remain deep and liquid.
Mr. Barr. Professor.
Ms. Cetina. Yes, I just wanted to make a point. There is a
beautiful piece of research from the St. Louis Fed called
``What About Japan?'' I highly recommend people on this
committee read it.
Basically, what they do is they nicely debunk the point
that Japan has higher government debt to GDP; therefore, we
should find solace in it. They point out that the Japanese have
significant foreign asset holdings, which tend to, when you net
those down, ameliorate their debt-to-GDP level. I just highly
recommend it because ``What About Japan?'' is often invoked to
say, let us continue on our----
Mr. Barr. Thanks. One final editorial comment is, look,
growth will not solve the whole problem. Obviously, fiscal
discipline is imperative, but we should focus on growth because
the more this economy grows, the less that debt is relative to
our overall GDP.
Let me talk about Treasury market structure a little bit.
That market has grown dramatically since the pandemic, from $17
trillion to $29 trillion today, and it is expected to double in
size over the next 10 years. As that market grows, obviously,
we need market participants.
Let me ask the banker, Mr. Wuerffel, why are banks
important intermediaries in a growing Treasury market?
Mr. Wuerffel. Thank you for that question. I think the
Treasury market, unlike some other markets, is an over-the-
counter market, which means it relies on intermediaries to move
securities and cash from one buyer and from buyers to sellers.
So, intermediation is essential to the Treasury market. It is
one of the reasons that we think that improving intermediation
and supporting intermediation is quite important. We have laid
out a number of steps to do that. It can improve market safety.
It can support market liquidity venues.
Importantly, we think targeted adjustments to the leverage
ratios, both the SLR and the Tier 1 leverage ratio, would be
important in helping to support the Treasury market's
intermediation capacity. Those ratios today constrain banks
from being able to intermediate, especially in times of stress.
It was intended to be a backstop, but now it is a constraint.
Mr. Barr. Yes, and Professor Duffie, can you also talk
about the importance of adjusting the SLR? I think there is a
consensus developing that the Fed is impairing the liquidity of
our Treasury markets by not recalibrating the SLR.
Mr. Duffie. Yes, Mr. Barr. The SLR is indeed a
distortionary form of capital buffer. It should be changed
without, in my view, reducing capital at the banks. As you
said, the Treasury market has grown by leaps and bounds. The
main concern is that the banks themselves have not been able to
grow as quickly as the Treasury market. As I answered to Mr.
Hill, the market capacity has to come from somewhere else,
including all-to-all trade.
Mr. Barr. That is the short-term solution. The long-term
solution is growth and fiscal discipline.
I yield back.
Chairman Lucas. The gentleman yields back. The chair now
recognizes the gentleman from Indiana, Mr. Stutzman, for 5
minutes.
Mr. Stutzman. Thank you, Mr. Chairman, and thank you to the
panel for being here today.
How many of you would agree that we needed a trade reset?
Yes? Sir? I mean, when is a good time to do it? There is never
really a good time to do it, and especially considering the
fact that we come off of 4 years of inflation, labor shortages,
a regulatory environment out of control, there is not a good
time to do it, but I will tell you what. I think that--I come
from the Midwest, and I was visiting schools in Jay County,
Indiana. When the school was built in the late 1970s, there was
about 6,000 students in that school corporation. Today, there
is about 2,300. So what does that mean? A lot of jobs left that
community. That community is a--I mean, people there are smart.
They are hardworking, great values. They are willing to do
whatever it takes for their families and for their community.
Instead, we have seen our policies just slowly push good
manufacturing jobs away. Agriculture is consolidated. That is
because of technology. I mean, that is not completely
government's fault. You know, there is good in that.
I will tell you what. Manufacturing has left the country
because of our trade policies. I applaud President Trump for
doing it. Like I said, is there a good time? Not really, and
especially considering what we just came off of the last 4
years.
My question is, we have seen the jobs leave. Liberation
Day, could it have been another day? Maybe April 16th would
have been a better day. I do not know but it needed to happen.
So, Mr. Jersey--or actually, any of you all could answer
this--would you agree that volatility in financial markets, it
is inevitable?
Mr. Jersey. Yes, it absolutely is. In fact, when interest
rates were similar to where they are today, and you go back to
the early 2000s, from 2004 to 2006, 2007 before the financial
crisis, the range of daily Treasurys was about the same as it
is today. So, this is not an unusually volatile period of time.
We get days and moments that are very volatile, and that is
where this illusion of liquidity that I have suggested we have
plays into things. At the same time, the market is not
unusually volatile on a day-to-day basis.
Mr. Stutzman. The other thing I would mention, too, I mean,
while we want to see our Treasurys, our securities solid, here
are some headlines. ``Trump hails $20 billion investment by
shipping firm.'' ``Siemens announces $285 million investment.''
``Trump announces a $500 billion AI infrastructure
investment.'' I know Apple has announced investment. All this
investment is coming into the United States. Is that a bad
thing? No, it is good. So, I appreciate the other side, and
people want to say Trump's tariff policy created all of this
volatility. Yes, it sure did. I have also had investors at home
say, you know what, I am making money in the market right now.
I mean, some do, some do not, right?
Does volatility generally make the job of a trader more
difficult? Anybody? Mr. Duffie.
Mr. Duffie. Yes. In some research that I did with
economists at the Federal Reserve Bank of New York, we showed
that volatility, as Mr. Jersey said, is a fact of life in the
Treasury market, and market illiquidity in the Treasury market
rises in lockstep with volatility. What we should really be
concerned about is when markets become illiquid beyond the
extent to which volatility suggests.
As we saw in March 2020, market dysfunction can be greater
than that associated with just fundamental volatility, and that
is what the government and the Fed should be focused on. Yes.
Mr. Stutzman. I want to say thank you. I just think that in
this case here, sure, there can be fingers pointed, volatility
did occur, but it was not a surprise necessarily. I mean, we
all kind of knew President Trump was going to have some sort of
tariff policy, and it is the ones that we are surprised by that
are the ones that hurt the most and have lasted the most.
I mean, if you look at COVID and what COVID did, did it
recover eventually? Yes, you can look at the trajectory, and we
are kind of back on the right trajectory, but there was a lot
of loss.
Anyway, thank you for your comments, and Mr. Chairman, I
will yield back.
Chairman Lucas. The gentleman yields back.
The chair now recognizes the gentlewoman from the great
State of Texas, Ms. De La Cruz, for 5 minutes.
Ms. De La Cruz. Thank you, Chair Lucas, and thank you for
the witnesses for being here today.
I am in deep south Texas, and I have really enjoyed the
conversation today and your remarks, so thank you so much for
that and your time.
This question is really for all of the witnesses. What do
you believe are the soundest steps that we can take to ensure
U.S. reserve currency status for as long as possible? I will
start with you, sir, Mr. Wuerffel.
Mr. Wuerffel. Thank you. What I will say is I will speak to
the Treasury market in particular, and I think, again, I would
go back to the safety and liquidity of the market. So things
that reinforce the Treasurys' security, safety, and their
liquidity, we see three key areas here.
One is to complete the central clearing rule in a timely
manner because that will improve market safety. We also believe
that improving Treasury market intermediation is very
important. We have talked about this, including an adjustment
for cash and Treasury securities in the leverage ratio that
will help intermediation in the market. Third, supporting
market liquidity. That can be done a number of ways, but it is
all about the ability to convert a Treasury security to cash,
so that is about connecting public and private liquidity hubs,
meaning you can move a Treasury security to where it needs to
go to be converted to cash.
Ms. De La Cruz. Thank you. Mr. Duffie.
Mr. Duffie. Thank you, Ms. De La Cruz. So as everyone seems
to have agreed today, the most important aspect of this is U.S.
deficits. So that is one component of dollar dominance.
More pertinent to today, Treasury market resilience is
crucial. Treasury markets are the anchor of dollar dominance.
It is also important, consistent with Mr. Wuerffel's comments,
that global investors feel that they can move dollars and
Treasurys easily around the world and that funding markets are
open. For this reason, the Fed's swap lines with foreign
central banks are crucial to ensuring that foreign banks have
access to dollar funding from their own central banks.
Ms. De La Cruz. Thank you. Mr. Jersey.
Mr. Jersey. Yes, thanks very much for the question. I
concur with my fellow panelists who have spoken before that
reducing the deficit in particular and getting it to below the
level of nominal GDP growth would be a major step to convince
foreigners in particular and global investors to invest.
Also something else that is going on right now that I have
to write about, unfortunately, just about every single week,
and that is the debt limit, the risk of default every time we
go through a debt limit crisis does affect people's perception
of the safety and soundness of U.S. Treasurys. Even though
everyone does expect us to always raise it, at some point, if
there is a misstep and someone forgets to vote or something
like that on the floor, anything that reduces the full faith
and credit of the U.S. Government in the eyes of foreigners is
going to be a pretty significant hit to Treasury liquidity.
Ms. De La Cruz. Thank you. Ms. Cetina.
Ms. Cetina. Thank you. I would talk about the three
mechanisms of, I will call it, credit creation in the U.S.
economy. First, we all agree on the fiscal deficit. So,
Secretary Bessent, Ray Dalio, everyone on this panel, getting
that down into like a 3 percent vicinity would be very helpful.
Second is credibility is backed by confidence in the
central bank and to the extent that there are discussions that
could radically alter the credibility of the Fed as an
institution, that is important to nip in the bud, I guess, is
what I would say.
The third point I would make is a lot of what we are
talking about here in terms of banks holding more Treasurys,
implicitly, in my view, that implies that banks have less
capacity to lend to the private sector. That is bad. I think we
need to recognize that implicitly in this conversation about
SLR is potentially banks lending less to small businesses in
the real economy. That is something that, again, is addressed
if we take care of the first problem on the fiscal deficit, so
thank you.
Ms. De La Cruz. Thank you so much. I would like to add to
this conversation that I recently introduced a bill called
Bringing the Discount Window into the 21st Century Act, which
would require the Federal Reserve to conduct a review of the
discount window, a key source of liquidity that small banks
rely on in times of stress. This seems to be a common theme
that you all have said throughout not only this hearing but in
our discussion today.
Thank you so much for your time. I yield back.
Chairman Lucas. The gentlelady yields back. The chair now
recognizes the gentleman, Mr. Downing, from Montana, for 5
minutes.
Mr. Downing. Thank you, Mr. Chairman, and thank you to our
witnesses today.
I am glad we are having this hearing today to discuss early
volatility in the Treasury market following President Trump's
determination that our trading partners trade fairly with the
United States. As everyone in this room is aware, this is
exactly what President Trump ran on, making sure the United
States is no longer taken advantage of. The trade policies of
the past several decades have failed this Nation, its workers,
and its communities. The U.S.' trade deficit in January totaled
a whopping $131.4 billion.
Despite the naysayers, the President's strategy is working.
The United States is currently negotiating with all of its
major trading partners. Just recently, the United States
announced a historic trade agreement with the United Kingdom,
creating unprecedented market access for U.S. producers, very
meaningful to my district, especially my beef producers, but
excited about that.
This was through tough negotiating posture, and President
Trump forced China to the table, promising to bring future
prosperity for the American workers. Already, companies have
pledged to invest hundreds of billions of dollars in the United
States and create hundreds of thousands of new jobs.
I am going to start first with Mr. Wuerffel. The U.S.
dollar has been the global reserve currency since World War II.
Having that status has allowed the U.S. to borrow at lower
costs, which stimulates economic growth and increases standards
of living. Critics say the President's trade policy has
permanently damaged the dollar's global reserve currency
status. Do you agree?
Mr. Wuerffel. Thank you for the question. I think what we
saw in April was high volatility, initially around trade
policy, and then that spilled over into uncertainty around
growth, inflation, and the path of fiscal and monetary policy.
I think markets reacted to that by expressing price volatility.
I think these types of episodes are useful reminders to focus
on the structural safety and liquidity of the Treasury market,
and it is that long-term ability to have a safe instrument that
can be converted to cash that really matters to the structure
of the Treasury market.
Mr. Downing. Thank you. Move on to Mr. Jersey. One theory
early on regarding this episode of volatility was that
foreigners dumped their Treasury securities and purchased other
nations' debt as an alternative for a safe haven asset. So two
parts, Is there any truth to this theory? If so, should we be
concerned?
Mr. Jersey. Unfortunately, we do not get some of the
official data on Treasury flows until June for the April
period, so we do not know that for sure. In my discussions with
investors from Asia in particular, there were some people who
said that they paused their purchases, right, as opposed to
actually going out and selling. Sometimes pausing purchases is
just as bad as selling out outright, depending on the liquidity
situation at the time because if they were a liquidity provider
and now all of a sudden that liquidity provider goes away,
prices will move to adjust to find----
Mr. Downing. Right, right.
Mr. Jersey [continuing]. the next incremental buyer.
Mr. Downing. Thanks. Yes, it is not the first time the
United States has seen volatility in the Treasury market. I
worry that unaddressed liquidity episodes will only further
erode the world's confidence in the Treasury market, which
jeopardizes our economic and national security.
I will move to Dr. Duffie. Are there any notable
similarities or differences between this most recent friction
in the Treasury market with any of the previous frictions that
we have had in the Treasury market?
Mr. Duffie. Yes. As was said by one economist, every market
disruption is special in its own way. So this one, I agree with
Mr. Wuerffel, was basically fundamental uncertainty coming out
of trade policy and then the reactions concerning inflation and
government policy going forward. It did not reach to the point
where it became a crisis, and to that extent, it was much
different than the COVID shock, which was a fundamental shock
to the macro economy.
Mr. Downing. Yes.
Mr. Wuerffel. So, I would make an important distinction
between those.
Mr. Downing. Thank you.
Mr. Wuerffel or Mr. Jersey, anything to add? We will start
with Mr. Jersey.
Mr. Jersey. Yes, I concur with that assessment. The fact is
the market was functioning, and the volatility never got to the
point where you had issues with clearing Treasurys or with
balance sheets that just did not exist for an extended period
of time. Again, a lot of the volatility that we saw was
headline-driven, so it was just investors getting in and out.
They were not sure what was going on, so they were reacting to
a variety of different headlines, and that created this
volatility. Remember, some of this volatility was not
necessarily just people selling Treasurys----
Mr. Downing. Right.
Mr. Jersey [continuing]. just the opposite at times where
there were people buying a lot of Treasurys during that period
of time, the 7th, 8th, and 9th of April, just when you look at
the trading.
Mr. Downing. All right, thank you.
Mr. Wuerffel, anything to add?
Mr. Wuerffel. You know, when I think about Treasury market
functioning in prior episodes, the real episodes of dysfunction
had three elements. One was price volatility. That can be
caused by fundamental uncertainty about different factors.
Second was that the liquidity of the market, the ability to
trade, deteriorated dramatically. Third is really about do
funding markets, the ability to finance the Treasury security
and borrow cash, start to express stress?
We have not seen that kind of trifecta in April. We did see
volatility in prices, deterioration in some liquidity, but
really, funding markets held up fairly well, and uncertainty
decreased over time, and I think market functioning was----
Chairman Lucas. Thank you.
Mr. Wuerffel. Mr. Chair, I yield.
Chairman Lucas. The gentleman's time has expired.
The chair now recognizes the gentleman from Wisconsin, Mr.
Fitzgerald, for 5 minutes.
Mr. Fitzgerald. Thank you, Chairman.
Mr. Wuerffel, I know we kind of went over some of this
stuff earlier this morning, but can you explain again how the
leverage ratio may discourage banks from providing liquidity to
the Treasury market, in particular, kind of in times of stress?
Mr. Wuerffel. Sure. The Treasury market requires
intermediaries to function well because it is not an exchange-
traded market. So, the capacity of intermediaries to carry out
that activity is very important.
The leverage ratio was designed as a backstop to guard
against risks, but today, it serves as, in some cases, the
first line of defense, and it constrains banks from
intermediating, especially in times of stress. What we would
say is that having a targeted adjustment to the SLR, as well as
the tier 1 leverage ratio could help boost capacity in those
times of stress so you are not bumping up against the leverage
ratio. If the policy objective is to support Treasury market
liquidity, it would help with that. It can also be done in a
way that continues to have a safe and sound banking system.
Mr. Fitzgerald. As U.S. debt issuance continues to grow, do
you believe that the current leverage ratio framework is
adequately supporting kind of the health and resilience of the
Treasury market?
Mr. Wuerffel. So as some of the panelists have noted, the
size of the Treasury market has really outpaced the growth in
intermediation capacity dramatically. So, that trajectory of
the government market is important, first of all, to have a
sustainable fiscal trajectory. That is important, but also to
support intermediation in that growing marketplace, and I think
that is why making these sort of targeted adjustments and
looking at the things that constrain capacity on intermediaries
is quite important.
Mr. Fitzgerald. As someone who represents a district that
is heavy in manufacturing, specifically light manufacturing,
and with the tariffs, that if I go back to 2020, it was kind of
a line of manufacturers kind of at my door saying, if there is
any way we can get an exemption, that would be wonderful,
right? That is kind of--that whole discussion has begun again.
Mr. Jersey, let me ask you kind of on a bigger scale, would
getting our fiscal house in order--I know we have talked a lot
about the national debt right now--as well as growing the
economy, which there was a couple references to President
Clinton and, what was the magic back then that got us back to a
balanced budget. How do you think that those changes could help
reassure investors that Treasurys are a safe haven asset,
really, of the entire world?
Mr. Jersey. Thanks very much for the question. It really is
just having a sound fiscal house, number one; and, number two,
ensuring a lot of these regulations are enacted so people know
that they can transact easily. That will certainly help
investors not only abroad but also here in the United States be
comfortable holding Treasury securities in both the long and
short term.
We have to remember, a lot of people adjust their interest
rate exposure using Treasury securities. So, let us say that
you own corporate bonds on one side. You might hedge that by
selling a Treasury or selling a Treasury future or paying in an
interest rate swap. All of those things are true. So, our
corporate bond market actually works better because we have a
liquid, sound, safe Treasury market. By enhancing liquidity in
the Treasury market, you are not only enhancing liquidity for
the government, but enhancing liquidity for businesses in the
United States as well.
Mr. Fitzgerald. Very good. Thank you. Chairman, I yield
back.
Chairman Lucas. The gentleman yields back.
The chair now recognizes the gentleman from Nebraska, Mr.
Flood, who is also Chair of the Subcommittee on Housing and
Insurance for 5 minutes.
Mr. Flood. Thank you, Chairman.
Continued robust demand for U.S. Treasurys is foundational
to our economy, and disruptions in the Treasury market have
enormous consequences for the United States and countries
around the world. The focus of this hearing today is the
volatility in Treasury markets in April, following the White
House announcements that tariff policies were going to undergo
a rehaul as part of what we call Liberation Day.
To recap, after the tariff announcements, the stock market
plummeted, and the 10-year yield initially dropped 20 basis
points before quickly jumping 40 basis points over the course
of the next couple of days. I would like to ask our panelists
about each of those events I just summarized separately to
better understand what may have caused them.
Let us start with the initial movement post-Liberation Day
where both the stock market went down and the 10-year bond
yields moved down as well. To my understanding, this movement
is roughly in line with what one would expect in the event of
instability in the stock market. Treasurys are considered to be
a safe haven, and often when money is pulled out of the stock
market, a natural safe place to divert it would be Treasurys.
As demand for Treasurys go up, yields should go up.
Mr. Wuerffel, Mr. Duffie, Mr. Jersey--and this is just
looking for a brief answer here--is it fair to say that it is
typical to see bond yields drop in the event of rapid flight of
capital from the stock market?
Mr. Jersey. Yes, it is. One of the things that you have to
realize during that period of time as well is not all Treasury
yields rose during that period of time. Short-term Treasury
yields actually went down because of the expectation of--I am
not saying this was my expectation; this was the market's
expectation--of a slower economy and a Federal Reserve going to
be cutting interest rates. In doing so, you saw, yes, 10-year
yields rose, but short-term yields like 2-year yields went
down.
Mr. Flood. Mr. Duffie.
Mr. Duffie. Mr. Flood, the fact that the Treasurys are a
safe haven for investors involves two different features. One
is the one you mentioned, and you had diagnosed it perfectly.
As risk rises, investors tend to flee to quality, and that is
the U.S. Treasury market. The second phase is once the risks
materialize into a serious crisis, many investors want to sell
their Treasurys and go to cash. It is at that point that
Treasury yields could rise if the market cannot handle that.
That is what we saw, for example, in the COVID shock. So, both
market depth and the quality of the U.S. Government's credit
are crucial to that safe haven role.
Mr. Flood. Mr. Wuerffel.
Mr. Wuerffel. I agree with the fellow panelists here. I
think the initial reaction was one that we typically see, which
is that, as a safe haven instrument, investors, when facing
risk, can move into Treasury securities. Some of that movement
then reversed as uncertainty spilled over into other questions
about the trajectory of growth and inflation and fiscal and
monetary policy.
Mr. Flood. Okay, great. That is what I expected. Now comes
the interesting part. Then the 10-year yields rise. We just
established that a drop in yields in an environment with a
flight of capital from the stock market is normal. That makes
this increase in yields, while the stock market continued to
remain volatile, seem so much stranger by comparison.
I have heard a few different explanations of this. One is
that inflation expectations had increased and that yields
responded to a new perception around inflation. A second was
that institutional investors were forced to liquidate positions
that were highly leveraged due to volatility. One more theory
was that foreign investors were spooked and trying to offload
U.S. debt altogether.
We will start on the other end this time with Mr. Wuerffel
and then go to Mr. Duffie and then Mr. Jersey. I would be
interested to hear from each of our panelists that I just
identified and what they think the cause of this Treasury yield
activity was specifically and whether it is one of the
potential explanations I just used or a combination of them or
something else entirely.
Mr. Wuerffel. Thank you for that question. I think it is a
combination of factors that uncertainty around, in the first
instance, trade policy, and then drove uncertainty around some
fundamental factors that drive interest rates, things like the
growth, the macroeconomic growth, the trajectory for inflation,
what fiscal and monetary policies might do, and even the size
of Treasury debt outstanding. So all of those things drive
interest rates, and there were upside and downside scenarios
for those, and I think that is why we saw such volatility in
the market.
Mr. Flood. Mr. Duffie.
Mr. Duffie. I agree. Inflation and fiscal uncertainty were
the main sources of volatility. We do not know yet, Mr. Flood,
whether in fact foreign investors did unload Treasurys. As Mr.
Jersey said, those data will only become available in June.
There are early indications: The Ministry of Finance of Japan
does publish faster data and show that around 20 billion of
U.S. bonds, corporate bonds and Treasurys, were sold around
early April. That is not an enormous amount. It sounds like a
lot, but it is not an enormous fraction of foreign holdings of
bonds. So, I am going to speculate that, once all the data come
out, we are going to find that there was not massive selling of
Treasurys, but there was repricing on the volatility that Mr.
Wuerffel mentioned.
Mr. Flood. I appreciate that, and my time is up, so I yield
back.
Chairman Lucas. The gentleman yields back.
The chair would like to thank all of our witnesses for some
really exceptional testimony today. I would note my one
takeaway is the financial markets are a lot like Congress. We
are both rational until we are irrational.
Without objection, all members will have 5 legislative days
to submit additional written testimony and questions for the
witnesses to the chair. The questions will be forwarded to the
witnesses for their response. Witnesses, please respond no
later than June 23, 2025.
[The information referred to can be found in the appendix.]
This hearing is adjourned.
[Whereupon, at 11:34 a.m., the Task Force was adjourned.]
APPENDIX
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MATERIALS SUBMITTED FOR THE RECORD
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