GSIB High Quality Liquidity Asset (“HQLA”) portfolios are a mechanism through which low rates in the front-end are exerting downward pressure on longer dated yields. Fed QE has filled bank balance sheets with low yielding reserves, and deprived non-banks of any yield at all in the front-end. An unconstrained investor can escape 0% yields by moving along the risk curve to Bitcoin, but GSIBs are confined by Basel III to the most prosaic investments. GSIBs have both limited balance sheet space and HQLA requirements, so they are optimizing their portfolio by exchanging 0.1% yielding reserves for Treasures. Over the past year they have purchased $350b in Treasuries, tilted towards longer dated maturities. In this post we review why GSIBs are purchasing Treasuries and illustrate the scale and maturity profile of those holdings based on recent regulatory filings.
Why are GSIBs Buying Treasuries?
The banking sector has significantly increased its holdings of Treasuries over the past year, but almost all the increase is from GSIBs. Most banks are understandably uninterested in hold assets yielding less than inflation, but those low yields can still be attractive after taking into account regulatory constraints. In prior posts we have shown how Basel III constraints force GSIBs to adjust their liabilities by pushing out institutional deposits, but those same regulations also place constraints their assets.
GSIBs are mandated to hold a sizable HQLA portfolio, but there is some degree of freedom in its composition. The highest quality Level I HQLA include reserves, Treasuries, and Treasury reverse repo. When reverse repo rates rose above IOR in 2018, GSIBs began reshuffling their HQLA portfolio out of reserves and into reverse repo. Now that IOR is at 0.1% and reverse repo is at 0%, GSIBs are shuffling their HQLA holdings towards Treasuries. Some are also significantly increasing their holding of Agency MBS, which is a slightly lower quality HQLA (Level 2a).
Note that the focus in this post is entirely on the bank operating subsidiaries (depository institutions), and that there is significant heterogeneity in Treasury holdings even among GSIBs. The increase in Treasury holdings has largely been in the GSIBs with big bank operating subsidiaries- JPM, BAC, C, WFC. These are the banks most impacted by QE, which filled their limited balance sheets with low yielding reserves. The other 4 GSIBs have different business models (SST and BK are focused on custodial services, while GS and MS are focused on investment banking).
GSIBs Have Moved Along the Rates Curve
Bank regulatory filings suggest that the bulk of the increase in Treasury securities has been in the 5 to 15 year bucket. The filings report Treasury holdings but do not offer a clean break down of Treasury holdings by remaining maturity. The closest breakdown provided lumps Treasuries with other securities such as foreign sovereign debt, state and local government debt, and commercial MBS. However, the level holdings of those other securities are little changed over the past year while Treasury holdings surged. The aggregate $350b increase in securities broken down by remaining maturity almost exactly matches the $357b increase in Treasury holdings. This lends confidence to the view that the GSIBs are moving further along the Treasury curve.
This marks a big shift in bank portfolio management since the crisis, where GSIBs were not very interested in Treasuries (the first chart above shows only $100b in holdings in 2013) and tended to stay within 5 years of maturity. GSIBs are now big buyers of Treasuries, though they still stay away from the very short and very long maturities. Note that a meaningful portion of their portfolio is going be hedged.
GSIB Buying May Not Be The Only Mechanism
Treasuries yields haven’t budged for months despite hot CPI prints, soaring commodity prices, the promise of even more Treasury issuance, and of course an accommodative Fed. Maybe the bond market believes that inflation is transitory. But there are also mechanisms in the financial system that can lead to subdued yields without having to make assumptions on ‘how smart the market is.’ GSIB HQLA portfolios are one channel, but there could easily be other classes of investors (e.g. foreign official or conservative retirement funds) that are bound by similar constraints and forced by the ZLB to move along the duration curve, putting a lid on yields.
When the steady increase in demand for repo financing from 2018 to 2019 pushed repo rates above IOR, GSIBs reallocated their HQLA portfolios into repo and became the marginal lender in that market. They ran out of money in September 2019 and repo rates exploded higher. Treasury coupon issuance going forward is extremely high, so eventually GSIBs and similar investors will also run out of money. That may be when yields finally rise, if the Fed allows it.