Fed’s Williams: Treasury Market Need Support for Next Big Shock

The New York Federal Reserve took unprecedented action to stabilize the Treasury market after it was disrupted at the start of the pandemic.

Offering a stark reminder that markets need to be strengthened to get prepared for the next big shock, New York Fed Bank President John Williams said on Wednesday.

In comments before the NY Fed’s virtual 2021 U.S. Treasury Market Conference, Williams noted that “Treasury and related markets experienced three abrupt and notable disruptions, each of increasing severity in the past decade”. Those disruptions provide “a stark reminder that these markets are not nearly as resilient as they should be,” he said.

“A well-functioning U.S. Treasury market is critically important for our economy and, in fact, the entire world,” he said. “It enables the safe and stable flow of capital and credit to households, businesses, and governments”, Williams added.

The three disruptions were the so-called flash rally of October 2014, the repo market distress in September 2019, and the dislocations caused by the COVID-19 pandemic in March 2020.

Speaking about the pandemic disruption, “the incipient breakdown in market functioning quickly spread to other segments of the U.S. and global financial markets, risking a broad-based pullback in the availability of credit that is essential for our economy.”

To deal with the disruption, which nearly froze the Treasury and funding markets in March 2020, the Federal Reserve offered overnight repos of up to $1T and made large-scale purchases of Treasury securities and agency mortgage-backed securities to support the functioning of those markets.

“The pace and amount of asset purchases during this period was unmatched,” he said, noting that at the worst point of the crisis, the Fed was purchasing more than $300B of Treasuries per week.

“When the Treasury market breaks down, when trading is disrupted, or when interest rates move in ways that are not based on fundamentals, the ripple effects can be swift — and devastating to the flow of credit to businesses and households,” Williams said.

He said it’s important that agencies work together to boost resilience of the Treasury market. “It’s also clear that we need not start from a position of how things are, but instead, how they should be. Let’s not think of how we can reform, but how we can design”.