Surge in "failed deliveries" of 10-year US Treasury bonds in December

According to data from the Federal Reserve, the scale of failed deliveries of ten-year U.S. Treasury bonds soared to the highest level in eight years this month, mainly due to the Fed's continuous reduction of its balance sheet since 2022.

As of the week ending December 10, the total amount of unsettled transactions involving the latest issue of ten-year U.S. Treasuries reached $30.5 billion, the highest since December 2017.

During the same period, the repo rate for this type of Treasury bond dropped into negative territory, with holders willing to lend bonds at a negative interest rate and borrowers agreeing to sell them back at a lower price the next day—this abnormal situation often leads to easier failures in settlement.

The shortage of bonds partially stems from a sharp reduction in the Federal Reserve's holdings in the November auction. Compared with earlier auctions of ten-year U.S. Treasuries this year, the Fed’s holdings have obviously declined, whereas the Fed typically provides its holdings for market borrowing, helping relieve supply tightness.

Jason Schuit, president of South Street Securities, a broker specializing in U.S. Treasury repo trades, pointed out that in November’s ten-year Treasury auction, the Fed purchased only half as much as in the previous three auctions: “The amount available to borrow is simply lower,” triggering a supply shortage and resulting in settlement failures.

Fed’s Balance Sheet Reduction Cuts Market Supply

In the November ten-year Treasury auction, $42 billion was sold to investors, and the Fed only applied for an additional $6.5 billion to replace maturing debt.

By contrast, in earlier quarterly auctions of the same $42 billion size this year, the Fed’s additional purchases were: $11.5 billion in February, $14.8 billion in May, and $14.3 billion in August.

This decline was due to the reduction in the size of the System Open Market Account (SOMA) maturing bonds at the Fed. The amount of SOMA holdings maturing on November 15 was just under $22 billion, while on February 15, May 15, and August 15, the maturities ranged from $45 billion to $49 billion.

The Fed began implementing its balance sheet reduction policy in mid-2022, only reinvesting when maturing Treasuries exceed the monthly cap.

This cap was raised from $30 billion per month in June to $60 billion in September. As a result, the Fed’s additional purchases in November’s auction, especially for three-year Treasuries maturing this year, were lower than in previous quarters, contributing to the reduction in additional purchases at last month’s auction.

U.S. Treasuries held by the Fed are typically available for market borrowing, so the decline in the Fed’s share directly reduces the supply of lendable bonds. Jason Schuit stated:

For this specific ten-year Treasury bond, the Fed’s purchase amount was half of the previous three cycles. This caused a supply shortage, resulting in settlement failures.

Analysis suggests the Fed’s balance sheet reduction policy has had a substantive impact on secondary market liquidity, and investors are facing increasing operational challenges in the bond settlement process.

Risk Warning and DisclaimerThe market involves risks and investment requires caution. This article does not constitute personal investment advice and does not take into account the specific investment objectives, financial situations, or needs of individual users. Users should consider whether any opinions, views, or conclusions in this article are suitable for their particular circumstances. Investment is at your own risk.