The US treasury market is currently at an inflection point where the supply of liquidity is falling and demand for it is rising. It holds implications for corporate treasurers’ investment strategies and cash positions; foreshadows volatility in money market rates, elevated longer-term yields and higher funding costs, warns Nate Wuerffel, BNY’s Head of Market Structure.

A new paper from BNY co-authored by Nate Wuerffel and Laide Majiyagbe, Head of Financing and Liquidity, flags the long-term structural issues impacting the US treasury market.

Fiscal and monetary policy is draining liquidity and increasing the amount of collateral in funding markets. The Federal Reserve is in the process of reducing the size of its balance sheet through Quantitative Tightening (QT), and at the current pace QT is expected to pull another roughly US$500bn of liquidity out of the financial system over the next year.

“The last time the Fed embarked on QT in 2019, too much liquidity was withdrawn, leading to dislocations that required the Federal Reserve to intervene,” state the authors.

Even as monetary policy withdraws liquidity, financing needs in the market are already growing. Barring fiscal policy changes, the US government bond market is on track to grow to over US$50trn outstanding in the next decade. “This will dramatically increase the amount of collateral that needs to be financed and put upward pressure on funding rates and term premia,” they argue.

Repo implications

Liquidity in the US treasury market has implications for money markets where corporates and others go for liquidity, tapping into short-term funding markets to invest in repo. “We see that the amount of treasury collateral is increasing in the repo market. That generally means we are putting more pressure on repo, which will increase repo rates,” Wuerffel tells Treasury Today.

Market participants, including corporates, go to the repo market to invest cash or finance their daily liquidity, he continues. “If you invest in treasury securities, you can also place cash in repo. Corporations will need to think carefully about their liquidity strategies in a world where there is more collateral and less liquidity from the Fed.”

He suggests corporates ensure they have as many options for liquidity on hand as possible. “If a firm typically finances itself in unsecured markets, such as the investment grade debt market, they should also consider building out their repo market capabilities too. There is more than one way to source or deploy liquidity if conditions are getting tighter.”

Corporates already active in the repo market could explore different types of repo like intra-day repo or early morning maturity triparty repo, he says.

“Private sector solutions should include better sources of contingent funding, including the ability to raise or deploy liquidity throughout the day – like early morning and intraday triparty repo – better ways of mobilising collateral when it’s most needed, more consistent margining practices and more efficient clearing capabilities.”

Regulatory changes

Regulatory changes are also impacting the liquidity in the US treasury market with implications for corporates. Risk and regulatory changes are making intermediation more challenging and banks more protective of their cash reserves. Bank and dealer capacity to intermediate in treasury markets has not kept pace with growth as regulations that have sought to make the financial system safer have in some cases come at the expense of market-making and liquidity.

“Structural changes are making the treasury market safer. But the liquidity dynamics of the market are changing as these new structures to create resilience make more demands on liquidity.”

Central clearing

Another important change coming down the line includes the introduction of central clearing of treasury market transactions in 2026, with technological, budgetary and liquidity implications. Corporates active in the repo market will have to think about how they work with their counterparties to centrally clear transactions.

“Negotiating the legal arrangements to centrally clear a trade could take six to eight months so corporates, broker dealers and all repo market participants need to be thinking ahead. Mid-2026 will be here sooner than people think.”

Central clearing will require market participants fundamentally to change the way they interface with the US treasury market in terms of trading and operational processes, he continues. Importantly, central clearing requires participants to post margin and make contingent liquidity commitments, which increases the demand for liquidity in normal times, and can exacerbate the demand for liquidity during times of stress.

The central clearing rule will convert what is counterparty credit risk today, into liquidity risk (and cost) tomorrow, he warns.