Cracks in the US Treasury bond market

This is an audio transcript of the FT News Briefing podcast episode: ‘Cracks in the US Treasury bond market’

Marc Filippino
Good morning from the Financial Times. Today is Monday, November 21st, and this is your FT News Briefing.

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Lebanon’s economic and political crises are fuelling a solar energy boom. Plus, our US capital markets correspondent is hearing creaks in the US Treasury market. But first, a new report links top global investment funds with China’s repression of Uyghur Muslims. I’m Marc Filippino, and here’s the news you need to start your day.

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The world’s top global investment funds are passively exposed to Chinese companies that are allegedly involved in the repression of China’s Uyghur Muslim minority. That’s according to a new report from two UK based research groups. The report identifies three MSCI stock indices. They include more than a dozen companies that allegedly profited from constructing internment camps and video surveillance equipment, or they allegedly use Uyghur workers obtained through a kind of forced labour system. So funds that invest in the MSCI indices, like giant asset manager BlackRock and Japan’s government pension fund, are exposed to these companies that are allegedly linked to Uyghur repression.

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Lebanon has been in a financial and economic crisis even before Covid. In 2019, the country’s currency collapsed and the war in Ukraine has made fuel imports even more expensive, all of which made Lebanon’s state-run power company even less reliable than it already was. But the crisis has been a boon for solar energy.

Raya Jalabi
You know, I sort of moved back to Lebanon in April 2022. And it had been six months since I was last in the country. And in that time, there was such an exponential increase just visibly on the streets when you’re driving around and seeing solar panels everywhere.

Marc Filippino
That’s the FT’s Middle East correspondent Raya Jalabi.

Raya Jalabi
On urban rooftops you are seeing them. You know, on agricultural land you’re seeing them. People are literally sticking panels on their balconies, on the backs of their bicycles.

Marc Filippino
Raya recalls power, as always, being unreliable in Lebanon. She said that’s because a lot of the country’s electricity infrastructure was damaged during the 15-year civil war that ended in 1990, and it was never rebuilt.

Raya Jalabi
So that meant that a lot of the country was experiencing rolling blackouts. It became a sort of normal thing to have several hours of blackouts a day. And as a result, businesses and individuals, households would have these back-up generators. And that’s really for those people who could afford it. So you could either have a private generator at home, in your building, in your neighbourhood, and you would pay a sort of expensive monthly fee in addition to electricity bills that you were paying. But when the crisis hit Lebanon in 2019, fuel imports became increasingly expensive.

Marc Filippino
So people began figuring out solutions on their own. And theoretically, the government could take advantage of this solar boom and could incorporate solar energy into the state grid. But . . . 

Raya Jalabi
We currently have no government to speak of. There’s a caretaker government that’s limited in its powers. There’s no president. So there’s a power vacuum at the top when it comes to policymaking. And there’s also legal issues. I mean, technically, the state-run utility Électricité du Liban has a monopoly on power. So individuals can’t actually sell any of that excess power that they produce for personal consumption on to anyone else, and they can’t feed it back on to the grid. Regardless, even the sort of basic premise of any policy that sort of suggests that we should be transitioning to, you know, all of these solar systems and renewable systems on to the grid requires a functioning grid, which we don’t have.

Marc Filippino
But the spread of solar in Lebanon isn’t just a happy tale.

Raya Jalabi
Someone I was talking to for this story, he said, you know, the sad reality is that the complete failure of the state has led to a cleaner energy shift, which in the grand scheme of things is a good thing. But the reality is that living in Lebanon is getting harder every day, just as a result of having to rely on all these diesel generators, the fumes being emitted from the, you know, the sort of diesel is difficult to tolerate. It’s hard to breathe in Lebanon. And so one hopes that with more and more solar uptake, that it would get to a sort of, you know, you’d have some cleaner air. But I guess the other main takeaway for me is that this is perpetuating energy inequality. I mean, essentially, you have large swaths of the population who are unable to afford it and are unable to even think about solar energy. I mean, I interviewed this one woman who said, you know, it was incredibly poignant because we were sitting in her living room in complete darkness and she said, you know, everyone’s talking about solar less and solar that, but for those of us who can’t afford it, we’re just living and dying in darkness.

Marc Filippino
Raya Jalabi is the FT’s Middle East correspondent. The world’s biggest bond market is creaky. I’m talking about the $24tn US government bond market. Investors all over the world view treasuries as a safe haven asset. And the size of this market has exploded. It’s doubled since 2012. But this year, liquidity in the US Treasury market has been drying up. The FT’s Kate Duguid recently wrote about this issue and she joins me now to talk more about it. Hey, Kate.

Kate Duguid
Hi.

Marc Filippino
All right. So what does it mean for this massive financial market to be creaky or for liquidity to dry up?

Kate Duguid
Sure. So it used to be the case that you could really easily buy or sell a huge chunk of treasuries. These days, it is not so easy to trade large sizes. So investors have been saying that they’ve been splitting up trades into smaller pieces, that it’s harder to identify a buyer sometimes. You know, they’re paying more for it obviously. They’re just all things that slow the process down. And so trying to buy or sell quickly in this market has become quite difficult. It may not sound like such a big deal, but it points to structural issues in the market.

Marc Filippino
Structural issues like what?

Kate Duguid
All right. So for about the past ten years, the composition of people who are participating in the Treasury market has changed pretty fundamentally. The primary dealers, so big banks that buy bonds directly from the Treasury department, they were kind of the traditional sources of liquidity in this market. They’ve been replaced over the past ten years with hedge funds and high speed traders. So what’s happened is those providers of liquidity haven’t always been consistent in the same way that banks were. And so finding buyers in that environment is going to be slightly more difficult anyway.

Marc Filippino
And what happened to the Treasury market that it got creaky this year?

Kate Duguid
The Federal Reserve began to raise interest rates. Treasury yields move with interest rates. They also move with inflation and growth. And all three of those things have kind of been in question all year long, which has really dramatically increased the amount of uncertainty in the market this year. So it does make sense that it’s harder to buy and sell in such an uncertain environment. But one of the things I was hearing when I spoke to investors for this piece is that liquidity has continued to deteriorate, even though uncertainty has basically stayed the same since the summer, suggesting that it may have more to do with underlying structural issues in the market rather than just these fundamental economic monetary reasons.

Marc Filippino
So the government, financial regulators, are they concerned about this? Are they doing anything to try and fix these problems?

Kate Duguid
Certainly, they can be fixed. And regulators have been talking about various fixes to these problems since 2014. One of the difficulties is that the Treasury market has a number of different regulators, and so that kind of makes it more complicated to regulate. But also, there is a lack of agreement about sort of what the best paths forward are. I will say that regulators in the Biden administration have been extremely ambitious and have proposed a number of new policies that would help stabilise the market. Here’s the thing, we may see the market meltdown before these new policies are actually in place.

Marc Filippino
A market meltdown. That sounds pretty intense. What would that look like and how and how nervous should we be?

Kate Duguid
To be clear, the market is not currently in crisis. We’ve seen a deterioration in liquidity and we’ve seen a lot of volatility, which is the way it happened in March 2020, was that we had this huge shock. Right? It was the onset of the pandemic. It was a shutdown of economies around the world. Usually in moments like that, people go into treasuries, right? People put their money into treasuries. They’re looking for a safe place to store cash. But there was a phenomenon that was happening in March 2020 where investors were trying to pull out of the Treasury market to access as much cash as they could. There was also this phenomenon where hedge funds had built up this levered position is one that is made with borrowed money. And that when hedge funds began to sell off, that really sort of exacerbated the selling. What was more of a problem were some of these structural issues that really exacerbated the crisis and made it hard to, made it harder to trade, made it hard to access cash and ultimately sort of ricocheted into other markets, right? Into stocks, into credit. Certainly, it’s a terrifying prospect, right? That the Treasury market kind of undergirds everything. And so it would be the systemic problem to end all systemic problems. But we’re not in that situation. And we do know that the Fed is going to step in if the Treasury market collapses.

Marc Filippino
So why do these cracks in the market matter, Kate, if the Fed is just going to step in and save the day anyway? Is it a matter of the markets seeming less safe?

Kate Duguid
Definitely changed the perception of the market, which is extremely important because this is a market that is used as a safe haven, not just for individuals or for investors, but for companies and countries around the world.

Marc Filippino
Kate Duguid is the FT’s US capital markets correspondent. Kate, thank you so much.

Kate Duguid
Thank you.

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Marc Filippino
You can read more on all of these stories at FT.com. This has been your daily FT News Briefing. Make sure you check back tomorrow for the latest business news.