What’s Really Going on with the Treasury Buybacks
Treasury Secretary Scott Bessent has described himself as the “nation’s top bond salesman.”
This week, the Treasury Department expanded an age-old sales tactic, offering a trade-in deal in which the market could exchange old bonds for new. The market reacted to this by bidding up bond prices, pushing down yields. Quite a few economic pundits, apparently high from sniffing the fumes of Trump Derangement Syndrome, decided that this meant the sky was falling.
More specifically, Treasury announced Wednesday that it would raise the maximum size of its buyback operations for bonds with between 10 and 30 years remaining until maturity. Beginning September 9, the limit will rise from $2 billion to at least $4 billion per operation.
This was immediately described by some as a radical intervention in the bond market, an attempt by Bessent to impose his will on interest rates, and even a form of quantitative easing. Because the announcement came one day after the yield on the 30-year Treasury climbed above 5.3 percent, its highest level in 19 years, and in the same week that the debt of the government crossed $40 trillion for the first time in history, it was all too easy for some to depict this as a crisis.
As we explained earlier this week, however, rising bond yields were a testament to economic strength not weakness, despite the financial media’s insistence that it was somehow due to “investor anxiety.” Similarly, the Treasury’s buyback announcement—which is an adjustment to a program begun by Janet Yellen during the Biden administration—does not signal that the sky is falling.
On the Run, Off the Run, and Liquidity
There is little doubt that Bessent was happy to see yields fall after the announcement. He has made no secret of his desire to bring down the government’s long-term borrowing costs and the mortgage rates that mirror them. Home affordability is one of the key complaints of many Americans about the economy. It is reasonable to conclude that the timing was meant to reassure investors that Treasury was paying attention to the recent volatility.
But it is not reasonable to view this as a sign that demand for U.S. government debt has collapsed or is undergoing a crisis. The word “buyback” may be part of what has people confused. When a corporation buys back its shares, the number of shares outstanding falls. (Although businesses are often issuing new shares to executives and employees that offset a big piece of this reduction.) When the Federal Reserve buys Treasury bonds, it creates reserves (or, in common parlance, prints money) and expands its balance sheet.
But neither of those things resembles a Treasury buyback. Instead, the U.S. Treasury is retiring particular bonds while continuing to issue other bonds. It is managing the composition and tradability of the national debt. No new money is created, and no net reduction in the debt held by the public occurs.
Importantly, the Treasury market is not composed of a single giant 10-year note and a single giant 30-year bond. Treasury sells new securities all the time, on a regular schedule. You can look it up on the Treasury Department’s website. The financial media covers these auctions in real time. Each issue has its own interest rate, maturity date, and identifying number, known as a CUSIP.
When a new 10-year note is issued, it becomes what traders call the “on-the-run” 10-year. This doesn’t mean it is a fugitive from justice, but it does mean it is the “most wanted” bond. It is the security quoted on financial television and used as the principal benchmark for 10-year interest rates. Dealers acquire inventories at the auction and distribute them to customers such as wealthy individuals, pension funds, mutual funds, corporations, and foreign buyers. Investors use the bonds to establish and hedge positions. Because everyone wants to trade the newest issue, dealers quote prices continuously and stand ready to transact in large quantities.
To illustrate what happens next, imagine that three months later Treasury issues another 10-year note. The previous note now has nine years and nine months remaining until maturity and becomes “off-the-run.” Nothing has happened to its creditworthiness. It is still backed by the same full faith and credit of the United States government. It has merely ceased to be the security around which the market has coordinated.
Liquidity, in this sense, can be looked at as a popularity contest. Investors prefer the bond everyone else is trading because they know they will be able to sell it quickly. Dealers offer tighter bid-ask spreads because they know they can readily find another buyer. Those tighter spreads attract still more trading.
The cycle works in reverse for older bonds. As activity migrates to the latest issue, dealers become less eager to warehouse its predecessors. A pension fund seeking to sell a large block of an older bond may have to wait longer, break the trade into smaller pieces, or accept a lower price. The bond can wind up yielding slightly more than an otherwise comparable new bond simply because it is harder to trade.
The difference in liquidity is enormous. Recently issued on-the-run securities account for less than four percent of Treasury debt outstanding but around 65 percent of average daily trading. The rest of the market consists largely of older bonds that trade much less frequently.
Treasury’s buyback program gives the market a regular escape hatch, a way to trade the older illiquid bonds for brand new liquid bonds. Suppose a dealer owns an older 30-year bond issued in 2016. The bond now has roughly 20 years remaining until maturity. It may have a low coupon, trade well below face value, and receive little attention from investors now focused on the newest 20-year bond.
How the Auctions Actually Work
Treasury announces that the old bond is eligible for an upcoming buyback. A preliminary list of eligible securities is published before the operation, and a final list is released on the day it takes place. Dealers and other approved counterparties then get a 20-minute window, typically from 1:40 p.m. to 2 p.m., to offer the bonds to Treasury through the Federal Reserve’s FedTrade system.
This works just like a regular bond auction but in reverse. In a normal Treasury auction, investors compete to buy debt from the government. In a buyback, dealers compete to sell debt back to the government. A dealer might offer to sell $100 million in face value of the old bond at a price of $82 for every $100 of principal. Another might offer $250 million at $83. Treasury compares the offers with prevailing market prices and with the relative value of similar securities. It accepts the offers it regards as attractive and rejects the rest.
This is important because the announced $4 billion is a ceiling, not a commitment. It refers to the face value of the bonds that Treasury is willing to retire, while the actual amount of cash paid depends on their market prices. Treasury can purchase less than the maximum. It can purchase nothing if sellers demand too much.
After the operation closes, Treasury publishes the results. Settlement ordinarily occurs the following business day. Treasury pays the successful sellers, receives the bonds, and retires them. They are essentially wiped off the books.
So the buyback program roughly looks like this:
- Treasury sells $4 billion of new, heavily traded securities.
- Treasury uses $4 billion to purchase older, less-liquid securities.
- The old securities are retired.
- The overall amount of government debt is essentially unchanged.
The government has replaced four billion dollars of old debt with four billion dollars of new debt.
Treasury also takes care not to remove so much of any bond that it makes the remaining supply even harder to trade. And Ii excludes the newest on-the-run bonds, securities in unusually strong demand in the repurchase market, and bonds that play important roles in Treasury futures contracts. Those exclusions reveal the purpose of the program. If Treasury were really trying to push down the headline 30-year yield, it would purchase the current 30-year benchmark that everyone watches. Instead, it deliberately targets older securities suffering from liquidity disadvantages.
What’s the Point?
So why go through all this trouble? Remember what Bessent said about being the top bond salesman. The buybacks are mainly a service provided to bond buyers, a way for the government to let investors know that it will make sure the market in the securities it is selling remains liquid. You don’t have to worry about your bonds going stale because you can also go to the reverse auction and trade your old bonds.
And then there’s the fact that Treasury may be able to capture the difference between the price of liquid and illiquid debt. Older securities sometimes trade at a discount relative to newer securities with nearly identical maturities. Treasury can buy the cheaper old bond and finance itself by issuing a new bond for which investors are willing to pay a liquidity premium. The government’s credit risk has not changed. Treasury has simply taken advantage of the market’s preference for the newest edition.
Finally, the reverse auctions free up balance-sheet capacity at the banks. A dealer—which is what banks and securities firms are called when they are buying and selling securities from the government through the New York Fed—that unloads $200 million of a thinly traded bond can use that capacity to make markets elsewhere. This matters because the Treasury market has expanded much faster than the balance sheets of the banks expected to intermediate it, in part because bank balance sheets are constrained by the capital and liquidity regulations put in place after the global financial crisis of 2008.
There is a good reason Treasury increased the limit at the long end. In the period covered by the Treasury’s most recent quarterly announcement, Treasury said investors offered $50.4 billion of bonds in the 10-to-20-year sector against a cumulative purchase ceiling of just $6 billion. They offered $95.1 billion in the 20-to-30-year sector against an $8 billion ceiling. Treasury repeatedly hit the existing limit because lots of bondholders wanted to trade in their old bonds.
This is not an indication that investors were desperately fleeing government debt. The figures show that dealers and their customers had large inventories of older bonds they were willing to sell at competitive prices. The operations were being used exactly as designed, and the $2 billion ceiling was constraining them. Treasury already authorizes buybacks of as much as $4 billion in the two-to-three, three-to-five, five-to-seven, and seven-to-10-year sectors. Wednesday’s announcement largely brings the long-end ceiling into line with the rest of the nominal Treasury curve.
The Buybacks Are Tiny Compared with the Market
Notice the scale of the buybacks. Under the currently published schedule, the increase adds at most around $14 billion of purchases before the November refunding. That is less than five one-hundredths of one percent of the $31.5 trillion Treasury market. The market trades around $1.2 trillion on an average day. In other words, the buybacks are a rounding error compared with the size of the market for Treasuries.
Treasury must, of course, obtain the cash used in the operation. It may temporarily pay out of its existing cash balance, but its financing needs are ultimately met through taxes and new debt auctions. New issuance replaces the securities that are bought back. The buybacks are best thought of as trade-ins rather than reductions in indebtedness.
This is not quantitative easing or monetizing the deficit. The Federal Reserve can create new dollar reserves to purchase securities and expand its balance sheet. Treasury cannot. Its buybacks must ultimately be financed through tax receipts, its existing cash balance, or the issuance of other debt. The government is changing the composition of its liabilities, not conjuring up money to make the debt disappear.
There can be a small interest-rate effect. If Treasury finances purchases of long bonds by issuing short-term bills, the private market winds up holding less long-duration debt and more short-duration debt. All else being equal, that should place some downward pressure on long-term yields and some upward pressure on short-term yields, which is exactly what we saw after Wednesday’s announcement.
The timing of the announcement suggests that it is likely that the Treasury Department did want to trigger this downward pressure on long-term yields, although the effect was always likely to be short-lived. Bessent may have seen some value in signaling to the market that he is paying attention to government borrowing costs and is willing to intervene if they get too volatile.
So why the panicky coverage? The simplest answer is that this is part of the campaign to depict the economy in as bad a light as possible ahead of the midterm elections. Combine that with the Trump Derangement Syndrome’s central tenet that everything the Trump administration does should be interpreted as a disaster. It’s just chicken little with a grudge against the sky.
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