▶ 0:12:35The task force on monetary policy, treasury market resilience, and economic prosperity will come to order. Without objection, the chair is authorized to declare a recess of the committee at any time. Without objection, all members will have five legislative days with on which to submit extemporaneous material to the chair for inclusion in the record. I'd now like to recognize myself for four minutes for an opening statement. This hearing is entitled Examining Treasury Market Fragilities and Preventative Solutions.
▶ 0:13:05Today, we'll take a 30,000 ft view of Treasury Market Structure with a particular focus on the market under stress. We will endeavor to use last month's volatility as a case study in current market conditions and functioning and examine what changes may have been helpful in improving the resilience of the market. We can't overstate the importance of this topic. A highly liquid and resilient Treasury market is fundamental to the global economy.
▶ 0:13:32There have been a number of episodes in recent years that have made us remember the enormous privilege we have of being the world's global reserve currency and boast safe haven asset status. Last month was one of those moments. We observed almost every measure of liquidity in the Treasury market declined rapidly over a 3-day period.
▶ 0:13:52Thankfully, the market is resilient and recovered quickly from the stress of the broader macroeconomic But challenges like last month remind us that we must safeguard our most important asset, our deep, liquid, healthy, sovereign debt market. We can bolster the resilience of the market by learning lessons from market stress we observed in 2014, 2019, 2020, and a few weeks ago. My it seems relevant, doesn't it, when you think about that.
▶ 0:14:22For example, in 2023, the SEC voted to mandate central clearing for cash transactions and repurchase agreements involving treasuries. This is a fundamental shift and a massive undertaking by market participants. I've been working with the SEC to ensure that firms have appropriate time to come into compliance. Similarly, we need to get implementation right.
▶ 0:14:44There are outstanding questions that need to be addressed and Chairman Atkins is well positioned with broad stakeholder feedback to clarify the rules execution. I've also repeatedly urged the credential regulators to exempt treasuries and reserves from the supplemental leverage ratio and the enhanced supplemental leverage ratio due to their lowrisisk nature. We should incentivize participation in the market, not make it cost prohibitive.
▶ 0:15:11The Treasury market has doubled in size since I was on the DoddFrank conference committee. We should reconsider some of the provisions enacted that have may have had adverse consequences and that disincentivized participation in financing our debt. In the last decade, we've seen a dramatic change changes I should say in buyers of treasuries. Some of this is positive. Innovation is driving demand.
▶ 0:15:39On the other hand, we should look carefully at what is causing some investors to leave the market. Our debt instruments need to retain their attractiveness to a broad array of participants. And I want to make it clear, there is no silver bullet here. The Treasury market will always be sensitive to macroeconomic challenges, but there are changes we can consider to improve this resilience.
▶ 0:16:04and I hope to work with my colleagues on both sides of the aisle to address these constraints. And with that, I yield back. The chair now recognizes the ranking member of the subcommittee, Mr. Vargas, for four minutes for an opening statement. Thank you very much, Mr. Chairman, and thank you for forming such an excellent panel. And I want to thank the witnesses for being here today. Thank you to each and every one of you.
▶ 0:16:30A resilient and liquid treasury market is critical not only to the functioning of our own capital markets but also to the functioning of markets around the world. The Treasury market plays a key role in the Fed implement implementing its monetary policy provides the benchmark risk-free rate for pricing other assets and finances our government at a low cost to the taxpayers.
▶ 0:16:53So last month when the Treasury market experienced volatility in the wake of President's Trump's liberation day, it was no surprise that many expressed alarm about the financial consequences surrounding the tariffs. We saw the 10-year yield jump more than 50 basis points, which represented the largest 3-day jump since 2001.
▶ 0:17:15And as this administration continues to publish policy edicts edits through truth social, a number of analysts have signaled concern that the market volatility is here to stay. Even though we did see relatively strong demand in the Treasury's auctions of 10ear and 30-year bonds following the initial movement in the market, all this uncertainty makes maintaining resiliency all the more important.
▶ 0:17:41But growing uncertainty isn't the only reason it's pivotal to shore up the strength of our Treasury market. The growth in existing Treasury market debt has brought new attention to the issue of resilience. And this growth is on track to continue. In fact, the nonpartisan Congressional Budget Office has predicted that the United States national debt held by the public over the next 10 years will grow from 30 trillion to 52 trillion. numbers.
▶ 0:18:11And they also found that extending President's Trump tax cut for the next 10 years would add 4.6 trillion to our national debt. Let's not forget that for all the talk about my colleagues on the other side of the aisle about the need for government efficiency and fiscal conser uh conservatism. The last president to balance a budget and produce a surplus was a Democrat, President Bill Clinton. And as the government issues more debt, it will need investors willing to buy it. And it's important that dealers continue to have the ability to buy and sell this new debt.
▶ 0:18:42So in order to have a strong treasury market, we also need to evaluate whether dealers maintain the capacity they need to intermediate. Given all these challenges, it is critical that we keep taking steps towards improving the resiliency of the Treasury market. That's one of the reasons why I have been glad to see that our financial regulators have undertaken several reforms aimed just at that.
▶ 0:19:02For instance, I am hopeful that the final rule requiring the central clearing of eligible transactions will, as former former SEC chair Gendler said, quote, help to make the Treasury market more efficient, competitive, and resilient. In order for that to happen though, it's essential that the market participants and regulators continue to work together to implement it. We've also seen steady progress on the increased data transparency and availability within the Treasury market.
▶ 0:19:30FINRA's decision decision to move from publishing weekly aggregate volume transaction data to publishing daily aggregate volume transaction data was a step in the right direction and I look forward to continue to explore other ways to ensure that our treasury market remains resilient for the foreseeable future and with that Mr. Chairman I again thank you and I yield back. I thank the gentleman and I appreciate his compliment about my being in the majority for that three and a half years of surplus.
▶ 0:19:57With that, uh, the chair now recognizes gentleman from the full committee, the chairman Hill, for one minute. Thank you, Chairman Lucas. Today's hearing will explore the recent volatility in the Treasury markets and potential regulatory changes to mitigate future risk and ensure liquidity.
▶ 0:20:13While we all witnessed the disruption in the Treasury market last month, the bond market can sometimes react sharply to sudden policy changes, irrespective of whether those policies come from former President Obama, former President and current President Trump, or even the Fed itself. The Treasury market is the world's largest and most liquid government bond market. And given its global and domestic importance, it's paramount that it remains resilient as possible during times of volatility. In all markets, volatility is probable and inevitable.
▶ 0:20:43And thus, poly policy makers must push for policies that ensure that the markets remain liquid and orderly with the goal of preventing or mitigating future episodes of volatility. I look forward to these excellent panelists views on recent Treasury market events and continue our policy conversation to ensure our US Treasury market resiliency. Thank you, Mr. Chairman. I yield back. Thank you, Mr. Chairman. Uh today we welcome the testimony of Mr.
▶ 0:21:13Nathaniel Werfl, head of product global collateral and head of market structure at BNY. Dr. Daryl Duffy Duff Adams, distinguished professor of management and professor of finance, graduate school of business and professor uh by courtesy department of economics, Stanford University. Mr. Ira, Jersey, chief US interest rate strategist and global rates team leader, Bloomberg Intelligence.
▶ 0:21:39Miss Jill Centina, executive professor of finance, Maize Business School, Texas A&M University. We want to thank each of you for taking time to be here and each of you will be recognized for five minutes to give an oral presentation of your testimony and without objection, your written statements will be made a part of the record. Dr. Warfl, Mr. Orl, would you now recognize for five minutes? Good morning, Chairman Lucas, Ranking Member Vargas, and members of the task force.
▶ 0:22:09Thank you for the opportunity to testify on the importance of US Treasury Market Resilience. My name is Nate Werfl, and I'm the head of market structure and the head of product for the global collateral platform, which supports financing of Treasury Securities at BNY. Prior to joining BNY, I spent 25 years at the Federal Reserve.
▶ 0:22:27In my last role, I ran the domestic markets trading desk, carrying out large-scale trading operations, intelligence gathering, and financial market analysis for the Federal Open Market Committee and the US Treasury Department, among other stakeholders. BNY was founded by Alexander Hamilton 240 years ago and has a long and interconnected history with the US Treasury Market ever since.
▶ 0:22:52We have become a global financial services company that helps make money work for the world by managing it, moving it, and keeping it safe. Our founder negotiated the first loan to the US government from the Bank of New York. Shortly thereafter, as the first Treasury Secretary, he laid out his vision for how the country would address the nation's debt. It was rooted in two core attributes: safety and liquidity.
▶ 0:23:19Government bonds would be safe because they would be backed in full by the US government on their original terms and liquid because they would be easily converted to cash at a fair market price by any holder. It proved to be a resounding success. We are proud of the role we continue to play supporting the US Treasury market including as the primary settlement provider among other activities. The Treasury market plays an important role in the lives of everyday Americans.
▶ 0:23:49It serves as a benchmark for borrowing rates for everything from mortgages to auto and consumer loans. At $29 trillion outstanding, the Treasury market has grown. And over the last decade, the market has experienced several episodes of dysfunction, including in 2014, 2019, and following the CO 19 pandemic. Most recently, the events that took place in April tested market functioning.
▶ 0:24:16They prompted investors to question the resilience of the market in the face of policy uncertainty and the potential impact on the future direction of growth, inflation, interest rates, and the supply of Treasury debt. The events serve as a reminder that the safety and liquidity of the Treasury market are essential to its continued functioning. Given the critical role of the Treasury market, over the last decade, both the public and the private sectors have stepped up work to improve the resilience of the market.
▶ 0:24:46One of the most consequential of these efforts is the SEC's central clearing rule, which should enhance financial stability by improving the willingness of market participants to continue trading in the Treasury market even in times of stress. The Treasury clearing rule is only one of several public and private sector solutions that are important to strengthen the safety and liquidity of the Treasury market. I would highlight three priorities.
▶ 0:25:10First, timely completion of the central clearing rule would reduce counterparty credit risk and improve financial stability. Implementation should provide a level playing field for all market participants. Be limited to Treasury security transactions and not inadvertently capture non-treasury trades. Continue the current industry and regulatory momentum to provide promote smooth implementation and avoid delays that lead to excessive transition costs.
▶ 0:25:40and result in consistent margin practices across the ecosystem. Second, a targeted adjustment to leverage ratios for cash and treasury securities can support the ability of banks to hold cash reserves and intermediate in the Treasury market. The leverage ratio was intended to be a backs stop, but today constrains banks from supporting Treasury market intermediation, particularly in times of stress.
▶ 0:26:09A narrow adjustment would be a more effective means of supporting Treasury market intermediation than alternatives such as lowering the overall ratio, which might result in increased activity and riskier assets. And third, faster, more reliable, and more efficient ways to exchange Treasury securities for cash are essential to support market liquidity.
▶ 0:26:31This includes discount window modernization, making it easier to move treasury securities across public and private liquidity pools and options for early and intraday repo. BNY commends the committee for its work examining the resilience of the Treasury market. And we look forward to working with you to support a safe and liquid Treasury market. I'm happy to answer any questions you may have. Thank you, Dr. Duffy.
▶ 0:26:58I may have spent too much time in reconciliation markups in the last 10 days. You are now recognized for five minutes for your oral remarks. Thank you, Chairman Lucas, and thank you for inviting me to testify today. Weaknesses in the structure and regulation of the Treasury Market raise the cost to American taxpayers for funding the government.
▶ 0:27:24These weaknesses also risk financial stability and effective monetary policy. For US treasuries to remain the world's premier safe haven asset and the anchor of dollar dominance, the intermediation capacity of the Treasury market must be greatly expanded. Although, as you said, Chairman Lucas, there is no silver bullet for this, regulators could uh the following uh policies.
▶ 0:27:50One, fix the capital regulation known as the supplementary leverage ratio or SLR. Two, encourage the emergence of all toall trade in the Treasury market. Three, transparently separate the Federal Reserve's purchases of treasuries that support crisis market functioning from the Fed's other asset purchases. Four, make further use of the Treasury Department's buyback program.
▶ 0:28:16To my understanding, Chairman Lucas, uh, Treasury Market regulators have sufficient authorities from Congress to address these policies. When CO 19 became a global pandemic in March of 2020, the Treasury market became dysfunctional because bond dealer balance sheets could not handle the surge of investor sales of treasuries. Last month, tariff policy shocks threatened a similar crisis.
▶ 0:28:43Until concerns about the resilience of the Treasury market are addressed, bond investors who anticipate a need to raise cash quickly in a future crisis will reduce their everyday reliance on US treasuries. The cost to American taxpayers will rise correspondingly. The SLR reduces the incentives of banks to buy safe assets.
▶ 0:29:04reserves, treasury repos, and short-term treasury securities have very low risk, but require the same SLR capital buffer as a risky real estate loan. The prices of long-term treasuries, however, are volatile in a crisis and are not risk-free from the perspective of a bond dealer. If regulators do reduce the SLR for safe assets, the resulting reduction in bank capital should be offset with other changes in capital requirements.
▶ 0:29:33The best capitalized dealers are those most able to provide liquidity to the treasury market, especially during a crisis. Investors should be enabled to trade treasuries not only with dealers, but also directly with each other on all to-all platforms. This would increase market capacity and resilience. It's notable that all to-all treasury futures markets maintained functionality even through the co shocks of March 2020.
▶ 0:30:00Incentives for the emergence of all to-all trade are improved by more central clearing, more posttrade price transparency, and eliminating the market practice known as done with trading by which investors who clear transactions through a given dealer are required to also trade with that same dealer. Regulators should push further in all three of these directions.
▶ 0:30:26Fed purchases of treasuries to support market functioning will probably be necessary in some future crisis, but could act at cross purposes with monetary policy or could even be confused with fix fiscal actions. The Fed should clearly distinguish its market function purchases from easing. Market resilience would also be enhanced if the Fed's Treasury market trades are settled at clearing houses.
▶ 0:30:55In some future crises, the Treasury Department could pay could play its own liquidity backs stop role by using its ability to buy back treasuries. When Treasury Secretary Bessant was asked last month about tariff related stresses in the Treasury market, he said, quote, "We have a big toolkit that we can roll out. We could up the buybacks." I agree with that.
▶ 0:31:21In conclusion, while already planned improvements and treasury market regulation, especially expanded central clearing, as Mr. Warfl said, are helping, these are not nearly enough. The capacity of the Treasury market should be significantly expanded. Treasury market regulators are well positioned to achieve this. Thank you. Thank you, Mr. Jersey. You are now recognized for five minutes for your oral remarks.
▶ 0:31:51Chairman Lucas, Ranking Member Vargas, and members of the task force. Thank you for the opportunity to appear today. I'm Ira Jersey. I serve as the chief US interest rate strategist for Bloomberg Intelligence, a research arm of Bloomberg LP. These views are mine alone and not necessarily those of Bloomberg or any of its employees. While the Treasury market remains the most liquid bond market in the world, that liquidity can sometimes be an illusion. We've repeatedly seen that in periods of stress or volatility, market depth can quickly vanish. This is not new.
▶ 0:32:19I warned of this fragility well over a decade ago, and recent episodes continue to underscore the challenges to liquidity in the world's most important market. I believe the root cause of these liquidity issues are structural and not easily rectified. Since the 2007 to 2009 global financial crisis, we've adopted regulations rightly aimed at ensuring a safer and fairer financial system. But they've come at a cost. Balance sheet constraints have reduced the capacity of market makers to provide liquidity during times of stress.
▶ 0:32:48Put differently, we traded a more resilient financial system for less resilient markets. This trade may be acceptable in principle, but we must be honest about its consequences. Also, the amount of Treasury securities outstanding also matters to market function. Market intermediaries such as dealers and banks do not have enough balance sheet flexibility to efficiently make markets in times of stress while also complying with all of these requirements.
▶ 0:33:14Many of the often suggested fixes will be helpful to market function, but none are sufficient to prevent bouts of volatility. Central clearing of treasuries and repurchase agreements, for example, will help prevent market dysfunction, but functioning markets don't prevent prices from moving sharply. One promising tool has been the sponsored repo market, which allows more efficient funding of treasury positions. Use of sponsored repo has grown to about $2 trillion, representing a substantial amount of repo trades tied to treasury transactions.
▶ 0:33:43But sponsored repo growth has recently stalled due to counterparty limits and delayed implementation of central clearing. Exempting treasuries from from the supplementary leverage ratio can also be helpful to liquidity generally, but it is not a silver bullet. Other regulatory constraints like the liquidity coverage ratio and the net stable funding ratio continue to limit how much risk banks can t and dealers can take and absorb, especially during volatile periods.
▶ 0:34:08Together, these rules discourage expanding balance sheets just when the market needs those balance sheets most. The market structure has also changed. Highfrequency trading firms now account for a large share of activity, but they tend to pull back during periods of volatility. Highfrequency trading firms contribute to the illusion of liquidity where the market seems deep until it suddenly isn't. Additionally, we need to be cautious about how we interpret recent volatility.
▶ 0:34:36Some worry that the use of leveraged basis trades involving Treasury futures and cash bonds has increased instability, but there's little evidence of a large-scale unwind. Futures open interest remains steady. Repo markets are functioning, and money markets have have not fled to the Fed's facility. Basis trades fears seem to be overstated. Finally, we must recognize that demand for global treasuries is ever changing.
▶ 0:35:01Private foreign investors now hold more long-term US debt than official institutions like central banks and sovereign wealth funds. That means more market risk is concentrated in hands that are sensitive to returns and hedging costs, not necessarily government policy mandates. Another major shift the past decade is domestic buyers having supplanted foreigners as the major purchaser of treasuries even following the end of the Federal Reserve's asset purchase program.
▶ 0:35:27Ultimately, the decision to purchase a Treasury security is one of economics. Does owning a treasury at a specific yield meet the need of an investment mandate? Does it fulfill a regulatory requirement? Is it at a market price where I think I can sell it for a profit or at least not a loss? These are just a sample of why treasuries are purchased, but ultimately it comes down to price. During periods of uncertainty or one-way trading, prices will move to meet demand.
▶ 0:35:55In closing, improving Treasury market resilience requires a comprehensive coordinated approach. There's no single fix that will uh that will change this issue. Volatility regularly occurs even within highly functioning markets, but there are always make ways to make the market more elastic such as allowing targeted regulatory flexibility during times of stress so that dealers can step in when they're needed most. That would give us a safety valve without compromising long-term financial stability. Thank you.
▶ 0:36:24I look forward to continuing this discussion. Thank you. Uh Miss Sadina, you are now recognized for five minutes for your oral remarks, Thank you. Good morning. I will begin by rec uh by discussing three drivers of higher Treasury volatility after the April tariff announcement. First, inflation expectations rose around the tariff announcement. For instance, the one-year zero coupon CPI swap rose from 2.3% in October to 3.6%.
▶ 0:36:536% after the tariff news. Treasury volatility increased because higher inflation expectations triggered a paradigm shift for some investment portfolio management. The common 6040 equity bond portfolio begins to break down as a strategy when expected inflation exceeds 3%. Replaced by alternative strategies that do not favor treasuries. Second, hedge funds have been trading the swap cash basis since the election.
▶ 0:37:22Simply put, hedge funds expect treasuries will be excluded from bank supplementary leverage ratios. Hedge funds expected banks to buy treasuries, buy more treasuries, and that the spread between sofer swaps and comparable maturity treasuries would rise. The unwind of this trade contributed to treasury volatility as well. Finally, the dollar weakened and this is important because the dollar typically strengthens in riskoff events.
▶ 0:37:49Dollar weakness was suggestive of foreign capital outflows from the United States. Recent data from Japan indicates Japanese private and official holdings of treasuries declined by about 20 billion in early April. Developments such as the sharp appreciation of the Taiwan dollar is also notable. These data suggest that Asian investors are rethinking their unhedged dollar exposures and perhaps dollar asset allocations more broadly and imply upward pressure on yields in US fixed income markets will continue.
▶ 0:38:20Thus, the increase in Treasury market volatility on the one hand reflected investor surprise to tariffs. On the other, these developments also reflect decades of economic policy undertaken with minimal consideration about their longerrun impact. These policies were enabled by trends such as disinflation from globalization, labor force growth, and low yields due to unconventional monetary policy. Trends that have been extrapolated that they will continue forever.
▶ 0:38:46However, these forces are now in retreat even as we face the problem that US government debt has simply grown large. History suggests that high government debt is often solved through inflation diminishing debt in real terms, but also eroding the currency's purchasing power. Movements in gold against the dollar over the last two years are close to meeting the IMF staff's definition of a currency crisis. Treasury market fragility and erosion of the US dollar status are interlin.
▶ 0:39:16What then should or should not be done and I here I will differ from my colleagues. First proposals for bank capital regulation are in my view a risky solution to treasury market fragility. Eliminating bank capital requirements for US treasuries when treasuries are exhibiting heightened price volatility is inconsistent with sound risk management. Also, US banks continue to have about 500 billion in unrealized securities losses as of today.
▶ 0:39:42A prolonged bare steepening move in treasuries is a plausible risk scenario that could have an even more negative impact on banks if treasuries become SLR exempt. After World War II, US government debt to GDP was roughly 100%. About 50% of US banking system assets were invested in treasuries at that time. And these positions did not require capital. So maybe we should do this again. But simply put, we are not living in the 1950s.
▶ 0:40:12In the 1950s, regulation Q prohibited US banks from paying interest on checking accounts. So about 75% of bank funding had zero interest cost. Given interest rate deregulation in the 1980s, due to the growth of money market mutual funds, banks must now compete for deposits. So today, it is impossible for banks to safely fund lots of longdated government debt.
▶ 0:40:33If anything, high bank exposures to longdated treasuries combined with the absence of quantitative regulation and weak supervision of interest rate risk means that a sharp rise in treasury yields can threaten bank solveny. This was the essence of Silicon Valley Bank. Second, the Federal Reserve's use of unconventional monetary policy has both contributed to unsound fiscal policy and been destabilizing to the banking sector.
▶ 0:40:59For this reason, I do not support proposals to exclude banks reserve balances at the Fed from the leverage ratio. Let's be clear that doing so permanently would remove all constraints on the size of the Fed's balance sheet. Finally, we need to use the right tool that is stabilizing fiscal policy, bringing the deficit down. I thank the committee for the opportunity to speak. Thank you. We'll now turn to member questions and the chair recognizes himself for five minutes for questioning. Mr.
▶ 0:41:28Jersey and then I'd like to get Mr. Warfl's thoughts on this also. Can you describe the functioning of the market during the high volatility last month? How were markets able to accommodate both high volume with low liquidity? So the well the answer is it did function uh the market price moved in order to find where demand met uh what was met.
▶ 0:41:54So in in a in a period for example overnight if we look at April 7th in particular where the uh where Asian investors came in after uh hearing some uh some news overnight decided to sell treasury securities. But at that point, remember there is a very limited pool of liquidity during those hours, right? So, so part of some of the volatility was more from a timing issue.
▶ 0:42:19And if you see, just look at how volatile the the market was um during that two-hour period from 10 at 10 pm our time to midnight. Once you got to 1:00 when Frankfurt opened and Paris opened and London opened, ultimately you had a bigger pool of liquidity and the and prices rebounded somewhat because you were able to find another pool of liquidity.
▶ 0:42:41the the the challenge we have looking at um looking at the Treasury market on a daily basis in a market that basically doesn't close is that you have to appreciate when those market moves occur and is that a a really a clearing price during that moment or is that the overall clearing price for the entire global market and I think that we experienced that during those three or four days in April. Mr. Warfl thank you for the question.
▶ 0:43:04uh you know April and April what I think we saw was that there was uncertainty around trade policy and that led into uncertainty about some fundamental um factors that drive interest rates in the treasury market including the path of interest rates the inflation the growth of the treasury market and its supply. What we see in the treasury market it's the safest most liquid market in the world. It trades about a trillion dollars a day in purchase and sale activity and about five and a half trillion dollars of repo financing activity a day.
▶ 0:43:32So it's able to withstand high degrees of volatility. Uh what we saw in April that the indicators of market functioning things like bid ask spreads and other indicators did deteriorate rapidly. Um however they recovered after some of the uncertainty was resolved. I think what I see in April is that it's sort of a cautionary tale a reminder that we need to focus on the safety and liquidity of the structure of the Treasury market to make it resilient going forward. Continuing with you Mr.
▶ 0:44:00Oral, you've testified that the SEC's clearing rule could improve market liquidity and resilience. Can you talk about the importance of getting implementation right, not just done? Uh we only realize the benefits of a rule like this if all the regulators are rowing in the same direction, wouldn't you say? That's an excellent question and I would agree that uh you know the central clearing rule represents the most significant change to treasury market structure in decades.
▶ 0:44:29Uh we think it's important because it will reduce counterparty credit risk and financial stability risk, but getting it right is paramount. The extension of the timelines that the SEC announced recently have been helpful. I think the market will be able to use that additional time to implement the changes, the necessary operations and legal documents. Um we think a fair and uh level playing field implementation of central clearing is important and that's achievable we think in the time frames given. Dr.
▶ 0:44:58Last week I spoke with Secretary of Vent on these issues and he testified that auctions had weaker investor demand. He suggested capital requirements may be playing a role there. What are the regulatory constraints on market participants balance sheets? And should regulators look at recalibrating the SLR and the ESLR to encourage intermediation in the Treasury market? Chairman Lucas, I agree with Secretary Bessant uh that capital plays a role.
▶ 0:45:29Uh however, well capitalized dealers are best positioned to bid aggressively in the auction. So capital constraints matter, but uh lowering capital altogether is is not a good idea. The distortionary effects of the SLR on the other hand should be corrected. There's no reason to penalize, for example, Federal Reserve deposits uh because of any sort of risk or illquidity. on on the contrary they're perfectly liquid.
▶ 0:45:53So improving the SLR but making sure that banks uh remain uh very well capitalized should be the priority uh both for treasury market resilience and also for financial stability generally. The fundamental challenge I think is this. The market's ability to intermediate is not commensurate with the tremendous growth and the issuance as many of you touched on. We've got to come up with a way to inter address that intermediate capacity moving forward.
▶ 0:46:22With that, my time is about to expire and the chair recognizes the ranking member of the task force, Mr. Vargas, for five minutes of questions. Thank you very much, Mr. Chairman. Again, I want to thank the panel for being here. Um, Miss um, Centina, you heard the comments that were made by Mr. Wflul regarding the central clearing rule.
▶ 0:46:47Do you have any comments to what he said, any No, I think um I think central clearing is foundationally important and can be helpful um to promoting greater stability in the treasury market and getting to uh better um controls around counterparty credit risk. I do think it's important that central clearing of treasuries be implemented. But if there's a need for um a bit more I'll say runway to make that be a uh effective roll out uh that that's sensible.
▶ 0:47:16I think of what would be unfortunate is if somehow um that were to just not happen which I don't perceive was uh Mr. Warfeld's uh Okay. So there there does seem to be some agreement there then. Yes. Any disagreement between any of the rest of the No. No. I I wholeheartedly agree.
▶ 0:47:35And in fact, if we go back to the 2007 to 2009 financial crisis, if we had central clearing of things like credit derivatives at the time, which we do now, the volatility probably would have been uh most mitigated very significantly. Um, and you know, central clearing, I think, is is a way to have a public good and uh be able to mutualize the risk of the of clearing of the market and especially treasuries because they're, you know, don't have credit risk. So, so they should be something that we should be able to easily clear.
▶ 0:48:07Dr. Duffy, I completely agree. Uh, increasing central clearing should remain one of the highest priorities uh of Treasury market regulators. It's crucial for Treasury market resilience and for financial stability. Okay. Now, I do want to ask now u I think it was Mr. Jersey, you said this, the amount of treasuries outstanding was an issue.
▶ 0:48:28And in fact, assume that today the national debt is 36 trill215 billion dollars and it's going up every moment. If my Republican friends are able to pass the big beautiful bill, will that number next year be higher or lower? Will it be more than $36 trillion or less than $36 trillion?
▶ 0:48:56Well, I think ultimately in order to cut our deficit that number that number our deficit forecast is for uh $1.8 trillion deficit this year and next year. So, um even if they pass their bill correct, do you agree with that? Oh, I'm sorry.
▶ 0:49:15Um I I don't have a particular forecast but my understanding is is that we are looking at deficits widening under the what's being discussed currently in in this uh chamber of congress and that that uh would increase financing needs. So I again going back to my fundamental position which is that we need to do more to bring the deficit under control.
▶ 0:49:36Um I think that this this is the root cause um of the issues that we are discussing um in this committee today which is uh the fact that we have not brought the budget deficit onto a glide path down and in fact could you talk a little bit about the problem of stagflation if we get into t stagflation because of the increase in our debt and the situation that we will find ourselves in if this big beautiful bill passes and tariffs and all the other chaos that we see.
▶ 0:50:05I I would like to go to to make the point that stagflation um to me is the risk that it poses to the US banking sector I think perhaps may be underappreciated. And the reason that I say this is that stagflation activates credit problems at banks, liquidity risk and interest rate risk all simultaneously. We have not experienced this in the US banking sector since the 1980s.
▶ 0:50:28So any bank that is even trying to make a I'll call it a strong effort to model what this might mean a macroeconomic scenario like this for themselves faces significant data limitations and challenges. Um so I do think this is a a very challenging environment and uh that that banks may face and the reason that I'm raising this in response to your question is that banking crisis the medium banking crisis according to IMF research adds about 34 percentage points
▶ 0:50:59in terms of debt to GDP when they occur. So to from my vantage point, avoiding a banking crisis is is is highly important to not seeing the Treasury market size expand massively because of a financial stability event and is something that I think is just 15 seconds left. I I would just say that again if we are going to tame the deficit and the debt, we can't continue down this giving huge tax cuts to wealthy people. It just isn't going to work.
▶ 0:51:29Thank you. With that, I yield back. Gentleman yields back. The chair now turns the gentleman from Arkansas, Mr. Hill, chairman of the full committee to be recognized for five minutes. Mr. Chairman, thank you, Mr. Lucas. Well, we're we're all concerned about uh the long-term unsustainable budget deficits, 7% of GDP.
▶ 0:51:49And let's be clear uh the crisis of 911, the crisis of the financial crisis of 07 to09 and the pandemic produced extraordinary reactions from the United States government spending period full stop paid for by borrowing money to fund those crises.
▶ 0:52:10and it's a bipartisan issue and to treat it in a partisan way uh doesn't make any difference to this hearing because the fact of the matter is we have that situation and if it was such a crisis then perhaps President Biden and then Speaker Nancy Pelosi wouldn't have authorized $6 trillion of new spending on top of a $2 trillion deficit that we were running anyway due to those crises. But let me start with uh uh you Dr. Satina.
▶ 0:52:40uh you you're I really enjoyed your testimony. Very very Um comment one, I take it I I took your your point about you're not a QE fan from your background. I'm not either. I thought it was a big mistake by previous Feds. Should we pay interest on reserves of the Fed? I I think that um to do so is basically equivalent to taxing the banking sector.
▶ 0:53:06um it becomes a heads you lose tales you lose proposition for the banking sector if we don't um pay any interest and the reason that I say that is that when uh policy rates were at zero uh this was a drag on banking sector performance and then if when rates are higher we also don't pay interest it's a drag on banking sector performance I do believe and I have published research when I was associate managing director at Moody's uh it was the first piece of research I published when I joined Moody's that unconventional
▶ 0:53:37monetary policy is credit negative for US banks and I really think this needs more discussion. Veralachari and others have published on this. Well, that's a it's where monetary policy links with our discussion today and it's why chairman Lucas and ranking member Vargas have such an important task I think to sort sort through that is one of the top issues on central clearing. I see a lot of uni unonymity on that point today and I think we've we've seen the benefits in the past and we see it now in the treasury market.
▶ 0:54:07Should central clear is central clearing seven days a week 24 hours a day Mr. Warfl uh uh thank you for the question. Uh I central clearing is not seven days a week 24 hours a day. Should it be the biggest most liquid market in the world generating$2 trillion dollars of new uh issuance every year? I think one of the really interesting things about the treasury market is its evolution over time and moving into a world where you can settle a treasury security.
▶ 0:54:36You can get cash for a treasury security in smaller increments of time at any anywhere in the world at any time of day is would be a real advancement in the treasury market. I think there's a lot of operational and mechanical steps that are needed to to get to that state. Uh Dr. Duffel, you talked about expanding capacity, you know, in the market. I thought that was that's again a theme of this task force. H what does that mean to you? How would how do you see expanding capacity in the mark treasury market? Uh thank you Mr.
▶ 0:55:06Hill. On a normal day the treasury market is the deserves the label of being the deepest and most liquid market in the world. It has plenty of capacity. It's really the surge capacity uh that's in question. In March of 2020 and to a lesser extent uh last month we saw that when investors around the world suddenly want to sell a lot of treasuries uh and volatility is very high the capacity of the market is stressed and and it's exactly at those moments that
▶ 0:55:36investors who had been holding treasuries in order to use them in a stressed market are having difficulty uh selling them. And so to me uh increasing the capacity means increasing the peak or surge capacity of the market by expanding the ability of dealers to absorb customer positions and if necessary by trading through allto-all platforms where you don't necessarily have to take up space on a dealer balance sheet. Yeah, that's that's helpful. Thanks for that.
▶ 0:56:07Uh should the Fed have a Treasury only balance balance sheet? Ideally, that's my view. um that that uh reduces is that shared does the panel share that view or you've served you've worked at the Fed Jill. What's your view on that? And I'm talking about long term like not in a period of crisis where they might choose another asset class. Should it be treasuries in the long run though?
▶ 0:56:29My my concern is that the Fed is so large that when the Fed disfavors agency MBS, it creates potentially um richness in the agency MBS market that may actually draw private investors into agency MBS and away from treasuries. The Fed is not a small actor in the bond market. It likes to pretend that it is, but it that is not the case. Thank you. I yield back. I appreciate the chairman's time. Gentleman yields back. The chair now recognizes the gentleman from California, Mr.
▶ 0:56:56Sherman, who's also ranking member of the subcommittee on capital markets for 5 minutes. We take some uh solace that we've been here with this large a debt right after World War II. But we should not because that debt could be paid off without increasing taxes or decreasing domestic spending because we ended World War II and we brought the boys home. So, we've never faced a crisis like this. We have a national debt that would embarrass Argentina.
▶ 0:57:25We've gotten away with it for a long time. Uh but now we're reaching points that even the United States may not be able to handle. We have to deal with the size of the debt, the fact that crypto has said that it wants to take some or all of the benefits of being the world's reserve currency away from us. We have to deal with the insanity of our current uh president.
▶ 0:57:53uh liberation day, no liberation day. Uh chaos is costly. Uh we uh have to deal with the effect of inflation and of course the Peterson Institute said that the Trump's policies would increase inflation over the next several years by uh four to seven and a half points.
▶ 0:58:13We have to deal with the international effect of the lack of the rule of law, the increase in obvious corruption, uh, and the attacks on the on the Fed, all of which undermine the image of the United States and the dollar. Um, we're paying an awful lot. I mean, the the the debt compounds on itself because we have to pay interest on the debt, which is now going to be the largest thing we spend money on, or we monetize the debt.
▶ 0:58:38And I think we ought to be looking more at that, not because it's a solution, but because it may be less painful than act than paying interest on the debt. Um the uh the chair of the full committee pointed out that we had $6 trillion of COVID spending. I should remind him that 70% of that was signed by Donald Trump. Um whereas I don't know a Democrat who voted for the 2017 tax cut. I don't know a Democrat that's going to vote for the tax cuts there.
▶ 0:59:07uh considering now um I want to uh thank uh uh Miss Satina for pointing out the importance of interest rate risk to our banks. That's what dooms Silicon Valley Bank and the idea of treating a long-term instrument federal or otherwise as risk-free uh ignores the fact that interest rates can go up and down.
▶ 0:59:36Um, let's see. Believe it or not, I do have some questions in here somewhere. Um, okay. three years ago was able to pass uh the the Liebore Act which dealt with $16 trillion of adjustable rate instruments where had we not passed that act the debtor and the creditor wouldn't know how much was to be paid because the index was no longer published. Uh Mr.
▶ 1:00:05WFL uh we've uh now changed from LIBORE to so far. Uh how's that going? Uh thank you for the question. Uh and I think the transition away from libore has been a a significant success. Um that's uh after many years of of work and I spent many years working on this problem at the the Federal Reserve.
▶ 1:00:27Um we've seen a quite smooth transition away that took a lot of work to make sure that the markets could successfully implement the change and then come out of it um functioning smoothly. I think it's perhaps a useful parallel to some of the um opportunities that the public sector has to support market change in the treasury market where adjustments to improve market safety like central clearing or targeted adjustments to the leverage ratio to improve intermediation or the ability to promote more liquidity in the market could
▶ 1:00:57be useful. Want to squeeze in uh one more question. We have a supplemental leverage ratio which is the key factor in banks determining uh their policies and it seems to discriminate against US treasuries by regarding them as no more risk-free than uh uh bonds issued by private uh players in the market.
▶ 1:01:23uh it uh the leverage capital requirements are insensitive to the fact that uh the uh the treasuries are are risk-f free as far as uh credit risk. Uh Mr.
▶ 1:01:39Worful, could you talk us through what happens in the broader financial markets if uh US treasury markets become less wi liquid uh perhaps uh as a result of the large banks feeling that uh they cannot hold uh US treasuries in the quantities they're used to. Thank you for that question. The the treasury market is the safest most liquid market in the world and it really hinges on those two characteristics of a treasury market. These are those foundational characteristics all the way back to Alexander Hamilton.
▶ 1:02:08It's a safe instrument to conduct a trade in and you can guar you're guaranteed the payment by the government. It's also a liquid instrument because it can change hands. So I think if you undermine either of those characteristics of the of a Treasury security, you have a risk of undermining confidence in it as an asset class. It's a huge uh asset to the US as a country and to to taxpayers that we have this market that allows us to finance the government at low cost. Gentleman's time is expired.
▶ 1:02:36The chair now the chair now recognizes the gentleman from Michigan, Mr. Heisinga, who is also vice chairman of the full committee for five minutes. Oh, thank you, Mr. Chairman. I appreciate your time and everybody being here today. This is incredibly important that uh we examine this. Um uh Dr. Duffy, let me start with uh you if I if I could please.
▶ 1:02:58Um you had mentioned this I think very briefly the uh altto all trading in in an answer to chair hill um and uh uh you you talked about the emergence of this and and how they are improved by greater use of central clearing we've talked about pretty extensively and more post trade transparency. You noted that regulators should push further in these directions.
▶ 1:03:22you you did say in your testimony encouraged and in I think in parenthesis uh uh although not mandate um so I'm curious as to the word choice and definition on that first of all but and can you help the committee understand how you believe this can be accomplished uh do you believe investors will get better execution increase competition by having more of this information uh yes Mr.
▶ 1:03:46His uh so it can be accomplished by some of the measures that I discussed in my testimony like more central clearing, more price trade uh uh price transparency and eliminating some practices that make it difficult for investors uh to trade uh with competition among different counterparties. By introducing all to all trade, investors uh can compete with each other for the opportunity to buy and to sell.
▶ 1:04:16They don't need to rely exclusively on a dealer uh to do that. They don't need to impinge on a dealer balance sheet to execute a trade. Markets will become more liquid uh because of improved competition and market capacity. How is that more transparent though? Well, it's uh more transparent in part because uh exchange exchange trading or allto trade provides more immediate price transparency and u more information on market depth. All right.
▶ 1:04:45Um will there be greater efficiencies, more liquidity? I mean we talked about transparency, but is there is there going to be efficiencies or liquidity added if this this is adopted? Yes, definitely.
▶ 1:04:59uh just as we see today in the futures market where we didn't have problems with dysfunctionality, you get greater efficiency because you have more investors that can trade directly and immediately with each other and not necessarily having to go through a dealer's balance sheet and waiting for the dealer to then onell the treasuries to another uh investor. So that's not to say that uh dealers wouldn't be part of the uh allto-all trade. They'd be the most important contributor and many investors would still want to trade directly with the dealer.
▶ 1:05:28But but these would not be in any kind of dark pool. It would be out out would there be some again with the central clearing I assuming that that's how this would have that gained transparency. That would be the ideal. But of course it would be up to regulators how to design uh the infrastructure and the regulations around that. But as you mentioned I don't think regulators should mandate that. An overly prescriptive regulation that forces all to all trade could have unintended consequences. Okay.
▶ 1:05:55Um, last week, uh, Rober Roberto Pearly, uh, who manages the Fed's roughly $6 billion securities portfolio, uh, said that one factor that contributed to the sharp rise in yields was due to the abrupt unwinding of the swap spread trade uh trade that both Mr. Jersey and Mr. Orle uh had highlighted in their testimonies. Mr. Jersey, could you uh briefly explain what the swap spread trade is and its role in the April April's volatility? Sure.
▶ 1:06:23So, so firstly let me say that uh the re one of the reasons why treasury securities are so liquid even though they are a very large uh there's a large amount outstanding is that we have an entire infrastructure of derivative instruments that investors and dealers and others can use to hedge them and swaps uh and interest rate swaps are just one of them. interest rate swaps right now are based on uh on sofur on the secured overnight financing rate.
▶ 1:06:50Um and uh investors when they get into a swap spread trade and and the trades that uh that unwound a little bit in early April were uh people were long treasury securities in the anticipation that the SLR would be amended to exclude Treasury. So people purchased Treasury securities and they paid or sold uh interest rate risk via swaps. Um and when uh when there was some doubt as to what the extent of the SLR would be or uh or those shifts, you saw an unwind of those of those trades.
▶ 1:07:20Um but to market function standpoint and and we're since we're talking about market function today um I would note that the repo market and other funding sources and other funding parts of those trades all functioned very smoothly even though there was very significant um movement in the price of both of those instruments both treasuries and interest rate swaps. I'm out of time, but I I was going to ask, could the SLR reforms have prevented or mitigated the impact of the Treasury markets that stem from the unwinding of the swap uh the swap spread trade?
▶ 1:07:50I'm out of time. We'll submit that question for writing, though, because I think that would be gentleman's time is expired. Gentleman from Illinois, Mr. Casten, is recognized for five minutes. Thank you, Mr. Lucas. Thanks to our witnesses. Um, so as my colleagues know, I spend a lot of time thinking about climate change and and trying to deal with it here. And my my sort of long-term concern is that our challenge dealing with climate change in this country is not because the physics is not understood.
▶ 1:08:18It's because it's become political to acknowledge the physics. And so the rest of the world looks at the United States and says, "When Democrats are in, you'll deal with this, but when Republicans are in, you won't." And so we can't treat the United States as a reliable partner. My fear in this hearing is that we are at a point where monetary policy is falling into that same bucket of things that should not be partisan but are. Um we have a naked emperor who has fallen in love with 1890s fiscal policy.
▶ 1:08:49Let's jack up tariffs. Let's go to hard money. Let's have light touch regulation. And we know from the 1890s that leads to 1890s style panics. Um but we can't talk about that. we can just talk about how nice the emperor's clothes are and you know so now we're finding ourselves with this scenario and I think Miss Satina you mentioned it has been an unprecedented month as all you know we had a collapse in US equity markets stapled to a collapse in treasuries that's not supposed to happen um and so
▶ 1:09:19I guess I'd like to start with you Mr. wereful um because last month BNY Melon um said the haven status of treasury securities is increasingly in question end quote and as foreign investors have been selling more treasuries is that still ongoing how concerned are you that that's a structural trend going on in our market right now? Thank you for that question.
▶ 1:09:41Um you know if you look at some of the longer term trends what we see in the treasury market for example in the last decade is that foreign holdings of the treasury market have gone down as a share of the treasury market size from about 50 to 30% over that 10-year period and then we also see es and flows in foreign participation in the treasury market and we did did see some flows but but I just challenge that because like over the I agree with those 10-year trends y but we also saw foreigners you know like the Japanese like the Europeans move from investing in the US economy
▶ 1:10:12via treasuries to investing in the US economy via equities. I don't think we've got a 10-year trend of people selling off equities and getting out of treasuries. Right. Yeah. Well, what I would say in the treasury market, as you've seen, you've seen a change in the composition of treasury market ownership. But just as some players have hold a smaller share, other players, for example, money funds, mutual funds have grown their share of the treasury market. I think the important thing is making sure it's a marketplace with a broad and deep buyer.
▶ 1:10:39Well, look, I I I understand what you're saying. I I also you're also making me only more scared because from your perspective, you don't want to annoy these folks over on the other side of the aisle by acknowledging what we know to be true. Bridgewwater just said that foreign investors are placing a risk premium on US assets and there is a quote slow bleed of support out of US markets, not just treasuries.
▶ 1:11:02Uh Bank of America, as you mentioned, Miss Satina, said 8.9 billion outflow into Japanese and European stocks at the end of April. If you had perfect, you know, foresight, you would have moved your portfolio into European equities on January 20th. And yet on January 19th, everybody was saying that the US economy was the envy of the world. Right?
▶ 1:11:24So I I guess Professor Satina, can can you help us understand if we've got this exit from treasuries, that's going to lead to higher treasury rates, right? It's going to lead to a weakened dollar, which means a more expensive cost for us to pay off our debt and ultimately, you know, some long-term threat to the reserve currency of the US dollar.
▶ 1:11:50How many of those changes are fixed once you put someone economically literate who's not beholden to Peter Navaro in the White House? And how many of those changes are irreversible? I I guess what I how I would respond to this question is that um I think we have foreign investment that has is quite broad in US financial markets and I think it's very important that US economic policy makers on both sides of the aisle recognize that we have what's called the net international
▶ 1:12:20investment position of the United States which is the accumulation of foreign portfolio investment which is the counterpart to our trade deficit which amounts to almost 80% of US GDP. So we need to pay attention for lack of a better word to uh you know our relationships with other countries how we communicate with them. Um this is very important.
▶ 1:12:42uh their investors you know less important investors in treasury markets but important investors you know in our investment grade corporate bond market in the equity market as you pointed out and to the extent that they decide that they want to hedge dollar holdings more hold fewer dollar holdings then basically I think what we're looking at is um in general equilibrium higher costs of capital for the US I could talk much more but I'm out of time thank you and yield Gentleman yields
▶ 1:13:12back. The gentleman from Kentucky, Mr. Bar, who's also chairman of the subcommittee on financial institutions, is now recognized for five minutes. Uh, thank you, Mr. Chairman. I suppose we could talk about um fiscal sustainability in the context of the Laffer curve and whether or not a massive tax increase on the American people would stifle economic growth to the point where it would worsen, not help our deficit and debt picture. I'm going to resist the temptation to launch into that debate.
▶ 1:13:42But let me just ask um any of you all uh based on professor uh Satina's uh point about the importance of fiscal responsibility, sustainability of our debt picture, I want to know what the tipping point is. Um can can any of you help the committee understand what is the tipping point? So we've got a $ 36 trillion national debt. It's 127% of our GDP.
▶ 1:14:09Uh there are other countries, a few handful of countries with higher debt to GDP ratios. Japan comes to mind, 250% um among the highest in the world. Uh when do the bond vigilantes come? Does anybody have an opinion about that where people start demanding much higher yield because it's a riskier asset? um it is the safest most deep liquid market in the world but when does that cease to be?
▶ 1:14:38Can anyone offer an opinion on that? So co congressman I've spent uh quite a lot of uh hours studying this exact issue trying to find that number that magic number of percent of GDP or or however else you you want to couch it.
▶ 1:14:53Um, but our our opinion in within our our strategy group at Bloomberg Intelligence is we're very close to that level where not that you'll just see a massive selloff in treasuries, but that treasury selloffs will become uh somewhat more pronounced and rallies will be shallower.
▶ 1:15:10So you know the the Treasury market at this point and I think given the fact that we are the reserve currency, we do have a very broad ownership base and buyer base and reasons for people to own it will um will continue to to see be cyclical with you know interest rates or with the economy but they're not uh where they're not just going to randomly sell off to say 10%. Uh we're not an emerging market.
▶ 1:15:33we are we until the reserve currency changes to something else the the US treasury market I think will remain uh deep and liquid professor yeah I just wanted to make a point um people often there's a beautiful piece of research from the St. Louis Fed called what about Japan? I highly recommend people on this committee read it. Basically what they do is they nicely debunk the point that Japan has higher government debt to GDP therefore we should find solace in it.
▶ 1:15:58They point out that the Japanese have significant foreign asset holdings which tend to when you net those down ameliorate uh their debt to GDP level. I I just highly recommend it because what about Japan is is often invoked to say let's continue on our Well, thanks. One final editorial comment is look uh growth won't solve the whole problem. We obviously fiscal discipline is imperative but we we should focus on growth because the more this economy grows the less that debt is relative to our overall GDP.
▶ 1:16:29Uh let me talk about uh treasury market uh structure a little bit. Uh that market has grown dramatically since the pandemic from 17 trillion to 29 trillion today and it's expected to double in size over the next 10 years. As that market grows, obviously we need market participants. Let me ask the banker, Mr. Warfl, uh why are banks important intermediaries in a growing treasury market? Thank you. Thank you for that question.
▶ 1:16:55I think you know the treasury market unlike some other markets is an over-the-counter market which means it relies on intermediaries to move securities and cash from one buyer and it's to from buyers to sellers. So intermediation is essential to the treasury market. It's one of the reasons that we think that uh improving intermediation and supporting intermediation is quite important. We've laid out a number of steps to do that can improve market safety.
▶ 1:17:18You can support market liquidity venues, but importantly, we think targeted adjustments to the leverage ratios, both the SLR and the tier one leverage ratio would be important in helping to support the Treasury market's intermediation capacity. Those ratios today constrain banks from being able to intermediate, especially in times of stress. It was intended to be a backs stop but now it's a constraint. Yeah. Um and uh Professor Duffy, can you also talk about the importance of uh of adjusting the SLR?
▶ 1:17:46Uh I think there is a consensus developing that the Fed is impairing the liquidity of our Treasury markets by not recalibrating the SLR. Yes, Mr. Bar. Uh it's indeed uh the SLR is indeed a distortion uh form of capital buffer. should be changed without in my view reducing capital at the banks. As you said, the Treasury market has grown by leaps and bounds. The main concern is that the banks themselves have not been able to grow as quickly as the Treasury market. So, as I answer to Mr.
▶ 1:18:15Hill, the market capacity has to come from somewhere else, including all toall trade. Well, that's the short-term solution. The long-term solution is growth and fiscal discipline. I yield back. Gentleman's gentleman yields back. The chair now recognizes the gentleman from Indiana, Mr. Settzman, for five minutes. Thank you, Mr. Chairman, and thank you to the panel for being here today. Um, how many of you would agree that uh we needed a a trade reset? Yes, sir.
▶ 1:18:44Any I mean, when is a good time to do it? There's never really a good time to do it. And especially considering the fact that we come off of four years of inflation, labor shortages, regulatory uh environment out of control, there's not a good time to do it.
▶ 1:19:01But I'll tell you what, I think that, you know, I come from the Midwest, and I was visiting uh schools in J County, Indiana, and when the school was built in in the late 70s, there was about 6,000 students in that school corporation. Today there's about 2,300. So what does that mean? A lot of jobs left that community. That that community is a uh I mean people there are smart. They're hardworking, great values.
▶ 1:19:32They're willing to do whatever it takes for their families and for their community. But instead, we've seen our policies just slowly push good manufacturing jobs away. Agriculture is consolidated. That's because of technology.
▶ 1:19:45I mean that's not uh you know completely uh you know government's fault that you know that's there's a good there's good in that but I'll tell you what manufacturing has has left the country because of our trade policies and uh and I applaud President Trump for doing it and and you know like I said is there a good time not really and especially considering what we just came off of the last four years. So, um, my question is is is, uh, you know, we've we've seen the jobs leave, uh, liberation day.
▶ 1:20:15Could it have been another day? Maybe April 16th would have been a better day. I don't know, but, uh, but it needed to happen. Um, so, uh, Mr. Jersey, or actually, you know, any of you all could could answer this. Would you agree that volatility in financial markets, it's it's inevitable? Yes, it absolutely is.
▶ 1:20:33And in fact, when interest rates were similar to where they are today and you go back to the early 2000s from 2004 to 20067 before the financial crisis, the range of daily treasuries was about the same as it is today. So it's not an this is not an unusually uh volatile period of time. We get days and moments that are very volatile and that's where this illusion of liquidity that I've suggested we have kind plays in uh plays into things.
▶ 1:21:00But um but at the same time the market is not unusually volatile in on a day-to-day basis. And you know the other thing I would mention too I mean while we want to see our treasuries uh our securities solid uh here are some headlines. Uh Trump hails $20 billion investment uh by shipping firm. Uh Seammens announces $285 million investment. Uh Trump announces a $500 billion AI infrastructure investment. I know Apple's announced investment.
▶ 1:21:31All this investment is coming into the United States. Is that a bad thing? No, it's good. So, you know, I I appreciate the uh you know, the the other side and you know, people want to say Trump's tariff policy created all of this volatility. Yes, it it sure did. But uh but I've also had investors at home say, you know what, I'm making money in the market right now. Well, I mean, some do, some don't, right? Um, does volatility generally make the job of a trader more difficult? Anybody?
▶ 1:22:03Mr. Duffy? Yeah. Uh, in some research that I did with uh economists at the Federal uh Reserve Bank of New York, we showed that volatility, as Mr. Jersey said, is a fact of life in the Treasury market and market illiquidity in the Treasury market rises in lock step with volatility. What we should really be concerned about is when markets become illquid beyond the extent to which volatility suggests.
▶ 1:22:31As we saw in March of 2020, uh uh market dysfunction can uh be greater than that uh associated with uh just fundamental volatility and that's what um uh the government and the Fed should u be focused on. Yeah. Well, I want to say thank you. You know, I just think that uh in this case here, uh sure, there can be fingers pointed, volatility did occur, but it wasn't a surprise necessarily.
▶ 1:23:01Um I mean, we all kind of knew Trump was President Trump was going to to have some sort of tariff policy and uh you know, it's the ones that you're we are surprised by that are the ones that hurt the most and have lasted the most. Um I mean if you look at uh COVID and what COVID did it recover eventually? Yeah, you could look at the trajectory and we're kind of back on the the right trajectory but there was a lot of loss. Uh but uh anyway u thank you for your comments and Mr. Chairman I'll yield back. Gentleman yields back.
▶ 1:23:30The chair now recognizes gentleoman from the great state of Texas, Miss Dea Cruz for five minutes. Thank you Chair Lucas and thank you for the witnesses for being here today. Um, I am in deep South Texas and uh I've really enjoyed the the conversation today and your remarks. So, thank you so much for that and your time. Um, this question is really for all of the witnesses.
▶ 1:23:54What do you believe are the soundest steps that we can take to ensure US reserve currency status for as long as possible? And um I'll start with um you sir Mr. uh we're thank you. Uh you know what what I'll say is the I'll speak to the treasury market in particular and I think again I would go back to the safety and liquidity of the market.
▶ 1:24:22So things that reinforce the Treasury security safety and their liquidity. We see three key areas here. One is to complete the central clearing rule in a timely manner because that will improve market safety. We also believe that improving treasury market intermediation is very important. We've talked about this u including an adjustment for cash and treasury securities in the leverage ratio that'll help intermediation in the market. And thirdly supporting market liquidity and that can be done a number of ways.
▶ 1:24:50Um but it's all about the ability to convert a treasury security to cash. So that's about connecting public and private liquidity hubs meaning you can move a treasury security to where it needs to go to be converted to cash. Thank you Mr. Duffy. Uh thank you uh Mr. Dela Cruz. So uh as as everyone seems to have agreed today, most important uh aspect of this is uh US deficits. So that's one uh one component of dollar dominance.
▶ 1:25:18Uh but uh more pertinent to today treasury market resilience is crucial. Treasury markets are the anchor of dollar dominance. It's also important consistent with Mr. Warfl's comments that global investors feel that they can move dollars and treasuries easily around the world and that funding markets are open. For this reason, the Fed's swap lines uh with foreign central banks are crucial to ensuring that foreign banks have access to dollar funding from their own central banks. Thank you, Mr. Jersey.
▶ 1:25:48Yeah, thanks very much for the question. So um I I concur with uh with my fellow panelists who have spoken before that reducing the deficit in particular and getting it to below the level of nominal GDP growth um is uh would be a major step to uh to to convince foreigners in particular and global investors to to invest. But also something else that's going on right now that I have to write about unfortunately just about every single week and that is the debt limit.
▶ 1:26:14um you know the the risk of default every time we go through a debt limit crisis um does affect people's perception of the safety and soundness of US treasuries um even though everyone does expect us to always raise it at some point if there's a if there's a misstep and someone forgets to vote or something like that on on the floor um you know we any kind of anything that reduces the full faith and credit of the US government in the eyes of foreigners is going to be a pretty significant um hit to
▶ 1:26:44treasury liquidity. Thank you, Mrs. Dina. Thank you. Um I would talk about the three mechanisms of I'll call it credit creation US economy first. Um we've all tal agree on the fiscal deficit. So Secretary Bessent, Ray Dallio, everyone on this panel. Um getting that down into like a 3% uh vicinity would be very helpful.
▶ 1:27:06Second is um credibility is backed by u confidence in the central bank and to the extent that there are um discussions that could radically alter the credibility of the Fed as an institution. That's important to um nip in the bud I guess is what I would say.
▶ 1:27:28And then the third point I would make is a lot of what we're talking about here in terms of banks holding more treasuries implicitly in my view that implies that banks have less capacity to lend to private the private sector. That's bad. Um I think we need to recognize that implicitly in this conversation about SLR is potentially banks lending less to small businesses uh and the real economy. that is something that um again is addressed if we take care of the first problem on the fiscal deficit.
▶ 1:27:58So thank you. Thank you so much. I would like to add to this conversation that I recently introduced a bill called bringing the discount window into the 21st century act which would require the Federal Reserve to conduct a review of the discount window. A key source of liquidity that small banks rely on in times of stress. And this seems to be a common theme that you all have said throughout not only this hearing but in our discussion today.
▶ 1:28:27Thank you so much for your time. I yield Gentle lady yields back. The chair now recognizes the gentleman, Mr. Downing from Montana for 5 minutes. Thank you, Mr. Chairman, and uh thank you to our witnesses today. Yeah, I'm glad we're having this hearing today discuss to discuss early volatility in the Treasury market following President Trump's determination that our trading partners trade fairly with the United States. You know, as everyone in this room is aware, this is exactly what President Trump ran on.
▶ 1:28:58Making sure the United States is no longer taken advantage of. You know, the trade policies of the past several decades have failed this nation, its workers, and its communities. The United States trade deficit in January totaled a whopping 131.4 billion. Despite the naysayers, the president's strategy is working. The United States is currently negotiating with all of its major trading partners.
▶ 1:29:22And just recently, the United States announced a historic trade agreement with the United Kingdom, creating unprecedented market access for US producers. Very meaningful to my my district, especially my beef producers. But excited about that. You know, this was through tough negotiating posture and President Trump forced China to the table, promising to bring future prosperity for the American workers. Already, companies have pledged to invest hundreds of billions of dollars in the United States and create hundreds of thousands of new jobs.
▶ 1:29:52So, I'm going to start first with Mr. WFL. You know, the US dollar has been the global reserve currency since World War II. You know, having that status has allowed the US to borrow at lower costs, which stimulates economic growth and increases standards of living. You know, critics say the president's trade policy has permanently damaged the dollar's global reserve currency status. Do you agree? So, thank you for the question.
▶ 1:30:18I think what we saw in April was high volatility initially around trade policy and then that spilled over into uh uncertainty around growth, inflation and the path of fiscal and monetary policy and I think the markets reacted to that in a uh by expressing price volatility. I think these types of episodes are useful reminders to focus on the structural safety and liquidity of the Treasury market.
▶ 1:30:42And it's that long-term ability to have a safe instrument that can be converted to cash that really matters to the the structure of the treasury market. Right. Thank you. Uh move on to Mr. Jersey. Uh one theory early on regarding this episode of volatility was that foreigners dumped their treasury securities and purchased other nations debt as an alternative uh for a safe haven asset. So two parts. Is there any truth to this theory? And if so, should we be concerned?
▶ 1:31:10Well, unfortunately, we don't get some of the official data on treasury flows until uh until June for the uh for the April period. So, we don't know that for sure. But in my discussions with investors from um from Asia in particular, um there were some people who said that they pause their purchases, right, as opposed to actually going out and selling. And sometimes pausing purchases is just as bad as selling out outright depending on the liquidity situation at the time.
▶ 1:31:36because if they were a liquidity provider and now all of a sudden that liquidity provider goes away, prices will move to adjust to find the next incremental buyer. Thanks. Um, yeah, it's not the first time the United States has seen volatility in the Treasury market. Um, I worry that, you know, unressed liquidity episodes will only further erode the world's confidence in the Treasury market, which jeopardizes our economic and national security. So, uh, I'll move to Dr. Duffy.
▶ 1:32:01Are there any notable similarity similarities or differences between this most recent friction in the Treasury market with any of the previous frictions that we've had in the TR treasury market? Uh yeah u as as was said by one economist every market uh disruption uh is special in its own way. So this one I agree with Mr.
▶ 1:32:25wereful was uh basically fundamental uncertainty coming out of trade policy and then the reactions uh concerning uh inflation and government policy going forward. Uh it didn't reach uh to the point where it became a crisis and in to that extent it was much different than the covid shock which was a fundamental shock to the macroeconomy. So I would I would make an important distinction between those. Thank you Mr. Warfl or Mr. Jersey. Anything to add? We'll start with Mr. Jersey.
▶ 1:32:53Yeah, I I I concur with that assessment. You know, the the the fact is the market was functioning and it never got the volatility never got to the point where you had issues with clearing treasuries or with uh balance sheets that just didn't exist for a extended period of time. Again, like the the a lot of the volatility that we saw was headline driven. So, it was just investors getting in and out. They weren't sure what was going on. So, there was they were reacting to a variety of different headlines and that created this volatility.
▶ 1:33:20remember some of this volatility wasn't necessarily just people selling treasuries just the opposite at times where there were people buying a lot of treasuries during that period of time the 7th 8th and 9th of of April uh just when you look at the trading right thank you uh Mr. anything to add? Uh, you know, when I think about treasury market functioning in prior episodes, the real episodes of dysfunction had three elements. One was price volatility that could be caused by fundamental uncertainty about different factors.
▶ 1:33:46Second was that the liquidity of the market, the ability to trade deteriorated dramatically. And third is really about do funding markets, the ability to finance a treasury security and borrow cash start to express stress. Um, we haven't seen that kind of trifecta in April. We did see volatility in prices, deterioration in some liquidity, but really funding markets held up fairly well and uncertainty decreased over time and I think market functioning was Thank you. Um, Mr. Chair, time is expired.
▶ 1:34:14Chair now recognizes gentleman from Wisconsin, Mr. Fitzgerald for five minutes. Thank you, Chairman. Mr. Warfl, I know we kind of went over some of this stuff earlier uh this morning, but can you explain again how the leverage ratio may discourage banks from pro providing liquidity to the treasury market in particular kind of in times of Sure. Uh you know so the treasury market requires intermediaries to function well because it's not an exchangeraded market.
▶ 1:34:45So the capacity of intermediaries to carry out that activity is very important. The leverage ratio was designed as a backs stop to guard against uh risks but today it serves as in some cases the first line of defense um and it constrains banks from intermediating especially in times of stress. Uh what we would say is that having a targeted adjustment to the the SLR as well as the tier one leverage ratio could help boost capacity in those times of stress so you're not bumping up against the leverage ratio.
▶ 1:35:15This can be done if the policy objective is to support treasury market liquidity. It would help with that. It can also be done in a way that rem you know continues to have a safe and sound banking system. And uh as US debt issuance continues to grow, do you believe that the current leverage ratio framework is adequately um kind of the health and resilience of the treasury market?
▶ 1:35:40So as some of uh the panelists have noted the size of the treasury market um has really outpaced the growth in intermediation capacity um dramatically. Uh and so that trajectory of the of the of the government market is is important first of all to have a sustainable fiscal trajectory. That's important but also to support intermediation in that growing marketplace.
▶ 1:36:04Um and I think that that's why making these sort of targeted adjustment and looking at the things that constrain capacity on intermediaries is quite important. Um, as someone who represents a district that's heavy in manufacturing, specifically light manufacturing, uh, and with the tariffs, uh, that, uh, if I go back to 2020, you know, it was kind of a line of, uh, manufacturers kind of at my door saying, uh, you know, if there's any way we
▶ 1:36:34can get an exemption, that would be wonderful, right? Um, and that's kind of that whole discussion has begun again. Um, but uh, Mr. Jersey, let me ask you kind of on a a bigger scale, would getting our fiscal house in order. I know we've talked a lot about the national debt right now, as well as growing the economy, which there was a couple references to President Clinton and, you know, what was the magic back then that got got us back to a balanced budget.
▶ 1:37:02How how do you think that those changes could help reassure investors that treasuries are safe haven asset uh really of the entire the entire world? Uh thanks very much for the question. I it really is just having sound fiscal a fiscal house number one and number two ensuring a lot of these regulations are enacted so people know that they can transact easily and that will certainly uh help uh investors not only abroad but also here in the United States.
▶ 1:37:31uh be comfortable holding treasury securities in in both the long and short term. We we have to remember a lot of people adjust their interest rate exposure using treasury securities. So let's say that you own corporate bonds on one on one side. You might hedge that with by selling a treasury or selling a treasury future or paying in an interest rate swap. All of those things are true and we're we're so our corporate bond market actually works better because we have a liquid, sound, safe treasury market.
▶ 1:37:58So by enhancing liquidity in the treasury market, you're not only enhancing liquidity for the government, but enhancing liquidity for businesses in the United States as well. Very good. Thank you, chairman. I yield back. Gentleman yields back. The chair now recognizes the gentleman from Nebraska, Mr. Flood, who's also chair of the subcommittee on housing and insurance for five minutes. Thank you, Chairman.
▶ 1:38:20Continued robust demand for US treasuries is foundational to our economy and disruptions in the Treasury market have enormous consequences for the United States and countries around the world. The focus of this hearing today is the volatility in Treasury markets in April following the White House announcements that tariff policies were going to undergo a recall as part of what we call Liberation Day.
▶ 1:38:42To recap, after the tariff announcements, the stock market plummeted and the 10-year yield initially dropped 20 basis points before quickly jumping 40 basis points over the course of the next couple of days. I'd like to ask our panelists about each of those events I just summarized separately to better understand what may have caused them. Let's start with the initial movement post liberation day where both the stock market went down and the 10-year bond yields moved down as well.
▶ 1:39:07To my understanding, this movement is roughly in line with what one would expect in the event of instability in the stock market. Treasuries are considered to be a safe haven and often when money is pulled out of the stock market, a natural safe place to divert it would be treasuries. Um, as demand for treasuries go up, yield should go up. Mr. Warfill, Mr. Duffy, Mr. Jersey, and this is just looking for a brief answer here. Is it fair to say that it's typical to see bond yields drop in the event of rapid flight of capital from the stock market?
▶ 1:39:39Yes. Yes, it is. And and and one of the things that you have to realize during that period of time as well is not all Treasury yields rose during that period of time. Short-term Treasury yields actually went down because of the expectation of I'm not saying this was my expectation. This was the market's expectation of a slower economy and the Federal Reserve going to be cutting interest rates. And in doing so, you saw yes, 10-year yields rose, but short-term yields like two-year yields went down. Mr. Duffy, Mr.
▶ 1:40:07Flood, uh the the fact that the treasuries are a safe haven uh for investors involves two different features. One is the one you mentioned and you had diagnosed it perfectly. As risk rises, investors tend to flee to quality and that's the US Treasury market. The second phase is once the risks materialize into a serious crisis, many investors want to sell their treasuries and go to cash. And it's at that point that treasury yields could rise if the market cannot handle that.
▶ 1:40:38Uh that's what we saw for example in the COVID shock. So both both market depth and the quality of the US government's credit are crucial to that safe haven role. Mr. Warfill, I agree with the fellow panelists here. Um, you know, I think the initial reaction was one that we typically see, which is that as a safe haven instrument, uh, investors will when facing risk can move into Treasury securities.
▶ 1:41:03Um, some of that movement then reversed as uncertainty spilled over into other questions about the trajectory of growth and inflation and fiscal and monetary policy. Okay, great. That is what I expect. Now comes the interesting part. Then the 10-year yields rise. We just established that a drop in yields in an environment with a flight of capital from the stock market is normal. That makes this increase in yields, while the stock market continued to remain volatile, seem so much more strange by comparison. I've heard a few different explanations of this.
▶ 1:41:31One is that inflation expectations had increased and that yields responded to a new perception around inflation. A second was that institutional investors were forced to liquidate positions that were highly leveraged due to volatility. One more theory was that foreign investors were spooked and trying to offload US debt altogether. Uh we'll start on the other end this time with Mr. Warville uh and then go to Mr. Duffy and then Mr. Jersey.
▶ 1:41:53I'd be interested to hear from each of our panelists uh that I just identified and what they think the cause of this Treasury yield activity was specifically and whether it's one of the potential explanations I just used or a combination of them or something else entirely. Uh thank you for that question.
▶ 1:42:08I think it's a combination of factors that uncertainty around in first instance trade policy then drove uncertainty around some fundamental factors that drive interest rates things like the growth the macroeconomic growth the the trajectory for inflation um what fiscal and monetary policy might do and even the size of treasury debt outstanding so all of those things drive uh interest rates and there were upside and downside scenarios for for those and I think that that's why we saw such volatility in the market Mr. Duffy, I agree.
▶ 1:42:38Uh inflation uh and uh fiscal uncertainty were the sources, the main sources of volatility. We don't know yet, Mr. Flood, whether in fact foreign investors did unload treasuries. As Mr. Jersey said, those data will only become available in June. There are early indications. The Ministry of Finance of Japan does publish uh faster data and show that around 20 billion of US bonds, corporate bonds and treasuries were sold around early April.
▶ 1:43:07That's not an enormous amount. It sounds like a lot, but it's not an enormous fraction of foreign uh holdings of uh of bonds. So, I'm going to speculate that uh once all the data come out, we're going to find that there wasn't massive selling of treasuries, but there was repricing on the volatility uh that uh that uh Mr. Wolf mentioned. Appreciate that. And I my time is up, so I yield back. Gentleman yields back.
▶ 1:43:32Uh the chair would like to thank all of our witnesses for some really exceptional testimony today. And I would note my one takeaway is the financial markets are a lot like Congress. We're both rational until irrational. Without objection, all members will have five legislative days to submit additional written testimony and questions for the witnesses to the chair. The questions will be forwarded to the witnesses for their response. Witnesses, please respond no later than June 23rd, 2025. This hearing is