- The Treasury market is important to global financing and the Federal Reserve’s monetary policy implementation
- Fed Governor Powell spoke on concerns over liquidity disappearing when it is most needed
- Powell believes increased regulatory costs should be accepted to increase financial stability
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Federal Reserve Governor Jerome H. Powell and New York Fed President William Dudley delivered commentary at a conference in New York today on the evolving structure of the US Treasury market. Fed President Dudley opened up with welcoming remarks and Governor Powell, via a pre-recorded video, gave a more detailed speech.
Dudley pointed to the crucial role that the Treasury market plays in the US economy including global financial markets. Furthermore, he stated the importance of the Treasury market for the Federal Reserve’s implementation of monetary policy and to underpin the US dollars status as the global reserve currency. As a risk-free benchmark for other financial instruments Dudley also mentioned Treasury securities purpose to serve as a liquid investment, hedging vehicle, and source of collateral for financial transactions.
Dudley laid out a list of questions to be discussed during the conference related to the changing composition of new firms that may be affecting the nature of market making and liquidity provision. He highlighted that in recent years, the structure of the Treasury market has changed significantly. Dudley touched upon recent remarks he made on market liquidity and the many open questions that remain on the subject of Treasury market liquidity.
Powell spoke of questions related to liquidity either being in broad decline or more prone to sudden disappearance and what the causes may be. He pointed to the fact that while most market participants perceive some reduction in liquidity, the views seem mixed on the severity of the situation. Powell said that considerations should be made for the risk of liquidity disappearing during times when liquidity is needed most, as in the event of the October 15 flash crash. He went on to say that such an episode, when Treasury prices fluctuated wildly with no obvious reason, threatens investors’ faith in the Treasury market – U.S. Treasury securities reflect the full faith and credit of the US government.
Powell touched on important trends that have been driving the changing structure of these marketsincluding: advances in computerized trading, intensified prudential regulation and supervision of the systemically important dealer banks. He stated that although post-crisis regulatory changes have likely increased the costs of market making, markets were undergoing dramatic changes before the crisis.
As many point to post-crisis regulation as a key factor of recent decline in liquidity Powell said it had little to do with events of October 15 but is still a factor driving changes in market making. Though, he believed that the same regulations have made another financial crisis far less likely and we should be prepared to accept increased regulatory costs to improve overall financial stability.