Inside Markets — Treasury Yields Explained

There’s been a lot of press attention on whether the backup in Treasury yields is due to foreign investor selling. The macro fundamental outlook may be changing at the margin, but foreign investors don’t seem to be behind the recent move in yields. Demand for Treasuries has been shifting from price incentive buyers (foreign central banks/ US banks) to price sensitive buyers (US investors) for more than 10 years. The pace of the demand shift accelerated after the US and Europe froze/seized Russian asset after the invasion of Ukraine. The source of the backup in yields seems to be hedge fund deleveraging. A handful of hedge funds have served as major intermediaries in Treasury markets since bank regulations were changed in the wake of the 2008 financial crisis. The rule change was the inclusion of Treasuries in bank leverage ratios, which effectively removed banks from their key role as market makers. The hedge funds that stepped in as Treasury market makers use maximum leverage and are therefor susceptible to rising funding costs. Recent volatility in markets has driven funding costs higher, prompting these hedge funds to de-lever by selling Treasuries. Unfortunately, recent bouts of deleveraging (2020 pandemic; 2023 regional banking crisis) did not reverse until there was policy intervention. The policy intervention could be an improved trade narrative, but it’s more likely to require Fed intervention. The longer-term solution is to exempt Treasuries from bank supplementary leverage ratios so they can return to their role as primary market makers.