Fed minutes flag Treasury-market leverage as a risk to financial stability
Minutes
of the Federal Reserve’s July meeting revealed that officials discussed
a number of risks involving the financial system. Photo: Jim Watson/Agence France-Presse/Getty ImagesReferenced Symbols
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Federal Reserve officials saw a number of vulnerabilities to the
financial system worth monitoring as of last month, one of which has to
do with the use of leverage in the Treasury market.
Minutes
of the July 30-31 meeting of the policy-setting Federal Open Market
Committee, released on Wednesday, said that participants regarded such
leverage as a risk. Their comments came during the part of the
committee’s discussion on financial stability, in which they also
considered it important to monitor any developments regarding the
Treasury market’s resiliency.
See also: Fed set to cut interest rates in September, FOMC minutes show. Some even favored July move.
The
use of leverage in the $27 trillion market for U.S. government debt has
been of concern since at least last year amid greater scrutiny of the
so-called basis trade.
The trade is a maneuver that involves taking a short Treasury futures
position and a long Treasury cash position, while borrowing in the repo
market to finance the trade and to provide leverage.
In a paper
released last August, staff at the Fed board and the Treasury
Department had indicated that the use of basis trades by hedge funds
warranted “continued and diligent monitoring.”
“The
basis trade remains pretty popular among hedge funds,” said
Lawrence Gillum, a Charlotte, North Carolina-based chief fixed-income
strategist for broker-dealer LPL Financial. “This
is something that has been an ongoing concern of the Fed’s now for
quite a while, but it is not adding to volatility in the market. It’s
more of a concern that has disrupted markets in the past and could
disrupt markets in the future, but is not something I see as an imminent
risk.”
Indeed, the Fed’s
July meeting minutes listed a number of other financial-system risks
worth watching. Those risks were seen as being linked to unrealized
losses on securities in the banking system, to exposures on commercial
real estate, and to cyber disruptions.
After the central bank’s minutes were released on Wednesday, 10-
According to a report by Bloomberg on Tuesday, leveraged positions in Treasury futures have risen to a record high ahead of the Fed’s annual symposium in Jackson Hole, Wyo. Some of those leveraged positions were attributed to the basis trade.
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