The 10-year U.S. Treasury note has been the go-to benchmark for finance in the U.S. and to a large extent globally. The Federal Reserve owns 24.8% of the on-the-run note. At some point, if the Fed owns too much of the supply, the cost of borrowing will not reflect economics and market risk factors. What will financial markets do?
A modest supply: Although the U.S. Treasury has added more than $3.5 trillion to outstanding debt since the start of the year, the issuance of 10-year securities has been consistent with the past few years. Most issuance in 2020 has been concentrated on the shorter end of the yield curve.
20% and counting: The owners of securities are critical to understanding prices and trading. The Federal Reserve now owns more than $4 trillion of U.S. Treasury securities. With 20% of the market, the Fed will start crowding out market participants if it buys many more securities.
Holding steady: Trading of Treasury notes* has remained steady at more than $100 billion a day. As the International Monetary Fund and others have noted, the Japanese government bond market, which was once robust, has suffered significant harm from Bank of Japan intervention.
The new normal: The COVID-19 pandemic has once again caused the Fed to employ extreme measures. Its monthly buying along with a general flight to the safest securities has caused interest rates to no longer reflect economic fundamentals. Real interest rates are negative and expected to be only slightly higher by 2022.
*Coupon securities due in more than six years but less than or equal to 11 years. Sources: SIFMA, Bloomberg LP