Behold: A Record Plunge In Primary Dealer Treasury Holdings

If you were looking for data to help support the narrative that the Fed’s silence on the looming expiration of supplementary leverage ratio exemptions is causing consternation, you could scarcely ask for something “better” than a record decline in primary dealer Treasury holdings.

Positions plunged by almost $65 billion in the week through March 3, the most recent data showed (figure below).

That’s a big drop, and as folks were quick to point out, it makes for an ostensibly odd juxtaposition with concurrent market action. If people are selling, you’d think inventories would expand, not contract.

The easy “answer” (and the one that’s most amenable to headlines) is to tie the decline to worries around SLR ambiguity.

The gist of Friday’s commentary around the data shown in chart (above) is that it may represent a downpayment on future selling in the event the SLR exemption is allowed to expire. That interpretation, to the extent it’s presented without regard for any nuance, may not be entirely accurate. The decline probably isn’t solely explainable by reference to jitters about SLR extension.

Note that a sizable portion of the decline was attributable to <6-year paper.

But it would be foolish not to acknowledge that a prospective “fumble” or “mishandling” of the situation could have unpalatable ramifications (and I spent an inordinate amount of time crafting that euphemistic assessment).

“We find it unlikely that the market has priced the end of SLR exemptions,” BMO’s Daniel Krieter and Daniel Belton said, in a note dated March 5. “We believe the difficulty in reducing reserves will result in considerable selling of Treasurys by G-SIB banks,” they went on to caution, adding that “if the SLR exemption is allowed to expire at the end of the month, the six impacted G-SIBs could shed approximately $400 billion in reserves and $200 billion in Treasurys.”

Others have voiced similar concerns.

“An expiration of the SLR exemption would have serious implications for bank capital and the Treasury market,” TD’s Priya Misra cautioned, in a Thursday note. “Banks have been the largest private sector buyers of Treasurys in the post-COVID world and a reduction in that demand should tighten swap spreads significantly,” she went on to say, before warning on the potential for balance sheet constraints to drive repo rates higher.

Misra also expressed some consternation around market functioning, with an emphasis on “stress events such as auctions,” given that SLR “creates frictions for dealer intermediation.”

These discussions are delightful — they allow analysts to employ and otherwise leverage rates phraseology to communicate dire outcomes in terms that, to everyday people, don’t come across as alarming. Equity analysts don’t enjoy that same leeway. For example, there’s no way to say that stocks might crash without using frightening terms. But make no mistake, “dealer intermediation friction” is bad.

“There was an anomaly in six-to-seven year holdings, which rose slightly,” Bloomberg’s coverage of the plunge in primary dealer positions observed. The same linked article noted that “this may reflect the disastrous auction during the same week, which saw dealers stuck with… the largest ever nominal take-down at a seven-year offering.”

Starting to get the message? If not, you might refer to “The Most Important Auctions In Recent Memory.”

In an effort to drive home the point, TD’s Misra wrote that “events such as the abysmal seven-year Treasury auction two weeks ago might become more common” if SLR relief isn’t extended.

That would be “particularly” true “when PTFs step away and balance sheet constrained dealers are unable to fill the void,” she added.