Regulation
Dealer balance sheet capacity returns to the agenda as Treasury supply outgrows intermediation
Marketable Treasury debt has grown 71 per cent since 2019 while primary dealer capacity to hold it has grown 24 per cent. The mismatch shows up as wider bid offer on the days it matters most.
In this story
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Every argument about Treasury market functioning eventually reduces to one ratio. The stock of debt that has to be traded has grown far faster than the balance sheet capacity of the firms obliged to make markets in it. That was an academic observation for most of the past decade because demand was abundant and the official portfolio was buying. It stopped being academic on Wednesday, when the decision to reinvest all maturing proceeds into bills removed roughly $38bn a month of coupon demand from a market that was already relying on dealers to hold what it could not place.
71%
Growth in marketable Treasury debt since December 2019
Against 24 per cent growth in primary dealer net Treasury positions
Dealers do not hold inventory because they want exposure. They hold it because a market maker who quotes a two way price ends up owning whatever the market wants to sell, and the position is financed overnight in the repo market until it can be distributed. Every unit of inventory consumes balance sheet, and balance sheet is constrained by a capital requirement that treats a Treasury bill and a corporate loan identically.
Treasury market size against dealer intermediation capacity
| Year end | Marketable debt outstanding | Dealer net Treasury positions | Positions as share of outstanding | Average bid offer, 30-year |
|---|---|---|---|---|
| 2019 | $16.7tn | $219bn | 1.31% | 1.9 ticks |
| 2021 | $22.6tn | $241bn | 1.07% | 2.2 ticks |
| 2023 | $26.4tn | $248bn | 0.94% | 2.8 ticks |
| 2025 | $27.9tn | $264bn | 0.95% | 3.4 ticks |
| 2026 to date | $28.6tn | $272bn | 0.95% | 3.9 ticks |
Dealer positions are period averages. Bid offer measured on the on the run thirty-year in normal market conditions, a thirty-second of a point per tick.
The third column is the one regulators look at and the fourth is the one investors feel. Dealer holdings have been flat at roughly 0.95 per cent of outstanding debt for three years while the market has kept growing, and the cost of transacting size at the long end has widened by more than half since 2019. Bid offer widening in calm conditions is a poor sign, because the days that test a market are never calm ones.
What the leverage ratio does
A temporary exclusion of reserves and Treasuries from the denominator was granted in 2020 and expired in 2021. The consultation closing in November revisits the question permanently, and the industry submissions so far ask for the same exclusion with a higher headline ratio to offset it. Opponents make the reasonable point that a backstop with carve outs is no longer a backstop, and that every crisis has produced a compelling argument for exempting whatever asset happened to be at the centre of it.
Dealers are not short of willingness. They are short of denominator. On a bad day the constraint is not the risk appetite of the desk, it is the ratio the group reports at quarter end.
Rufus Ohara, head of credit research at Ledgerbrook Partners
Where it shows up first
Auction allocations are the cleanest evidence. Primary dealers are obliged to bid in every auction and absorb whatever the other bidders leave. Their share of thirty-year auctions has risen from 11.4 per cent last October to 22.8 per cent in August, which means the obliged buyer is taking twice as much paper and then distributing it into the secondary market over the following sessions.
Primary dealer share of thirty-year auction allocations
Per cent of issue absorbed by primary dealers, monthly auctions.
22.8%
Primary dealer share of the August thirty-year auction
From 11.4 per cent in October, against a ten year average near 13 per cent
The repo market is the second place. Financing inventory requires balance sheet at the dealer and collateral capacity at the counterparty, and when both tighten at once the secured rate lifts away from the floor. That is exactly what happened on August 28, when overnight secured funding traded 14 basis points above the floor rate and stayed elevated for four sessions. Reserve scarcity explained part of it. Dealer capacity explained the rest, and only the first of those is addressed by the reinvestment decision.
Secondary market depth is the third and least visible. Depth measures how much can be transacted at the quoted price before that price moves, and on the on the run thirty-year it has fallen by roughly a third since 2023 on the estimates Ledgerbrook compiles from dealer runs. A market can look liquid on a screen, with tight quotes and continuous prices, while the size behind those quotes has quietly halved. The days that reveal the difference are the ones when a large holder needs to sell, and by then the measurement is academic.
What the consultation is likely to produce
- A permanent exclusion of central bank reserves from the leverage denominator, which has the broadest support and the weakest objections, since reserves carry no credit or duration risk at all.
- A partial exclusion for Treasuries held in a market making book, conditioned on turnover, which is administratively awkward and therefore the most contested element.
- A higher headline ratio to offset either exclusion, which the industry accepts in principle and will contest in calibration.
- New disclosure of intraday balance sheet usage in Treasury market making, which several submissions propose as an alternative to changing the ratio at all.
- An expansion of eligible collateral at the standing repo facility, which is scheduled for review in December and would relieve the financing side without touching capital rules.
Capital rules and the portfolio decision are now the same conversation. You cannot hand the private market more duration and also make it expensive for the private market to warehouse duration.
Ines Marchetti, head of rates strategy at Harrow Lane Capital
None of this resolves before the thirty-year auction on Thursday, which is the practical test of whether real money will take down the paper at 5.2 per cent or whether the obliged bidders will be holding a quarter of it again. The consultation closes in November and any rule change would take two years to implement. The supply arithmetic that makes the question urgent arrives every month in the meantime.