We have from time to time chronicled how various Treasury and Federal Reserve interventions have produced unintended, undesirable consequences.
The latest example: the Fed’s efforts to push Treasury rates into ZIRP-land is reducing the incentives of traders to repo Treasuries to each other. That then reduces liquidity in the Treasury market.
Consider the boldfaced statement from a Financial Times article:
When rates tumble to low levels, it reduces the economic incentive to lend securities. The reduction in liquidity in the $5,800bn Treasury market comes at a time when conditions have become strained as the calendar year draws to a close.
The problems also come as the US Treasury prepares to issue a massive amount of new government bonds for the current financial year.
“Low rates are having a corrosive effect on the repo market, which will impair liquidity in Treasuries,” said Michael Cloherty, strategist at Banc of America Securities. “We are getting close to a situation where structural damage caused by low interest rates outweighs any benefit from easier monetary policy.
“In a [financial] year where the Treasury is facing a net financing need of roughly $1,800bn, lower trading volume is a major concern.”….
“The zero per cent interest rate environment is effectively eliminating the dealer matched-book business and crippling dealer intermediation in the repo market,” said Scott Skyrm, senior vice-president at Newedge, a repo broker dealer.
Fails to deliver are another side effect.