Dash for cash: Treasury yields up 64bp in a crash

Everyone needed dollars at the same moment. Research published by the BIS identifies three groups selling in a hurry: bond mutual funds, foreign official investors such as central banks, and hedge funds. Foreign investors, official and private, sold a net of about $420bn of Treasuries in March, by one Fed staff estimate.

The hedge funds were unwinding the basis trade. As volatility spiked, futures margins rose and repo funding became harder to roll over, so leveraged funds sold the cash bonds; hedge funds’ Treasury exposure fell by more than $200bn during March. Research at the US Office of Financial Research concluded the unwind was more a result of the stress than its root cause, but it added to the selling.

The sales landed on dealers, the banks that stand between buyers and sellers. Their balance sheets, limited by capital rules, couldn’t absorb the flood. When the middlemen are full, even the deepest market stops working.

The standard hedge failed. A portfolio of stocks and Treasuries is meant to cushion itself in a crash, but for about two weeks in mid-March both fell together. Leverage was the amplifier: the BIS described forced selling of Treasuries by investors who had borrowed to exploit tiny price gaps, a margin spiral of the kind more usually seen in riskier markets.

It was also a global dollar squeeze, and the dollar rose as foreign borrowers scrambled for it. The Fed answered through the plumbing. Its swap lines lend dollars to other central banks against their own currencies, easing strains in dollar funding abroad.

On 15 March it cut the cost of its standing lines with five major central banks by 25bp. On 19 March it opened lines with nine more: up to $60bn each for six of them and $30bn each for Denmark, Norway and New Zealand. On 31 March it launched the FIMA repo facility, letting foreign central banks borrow dollars overnight against their Treasuries instead of selling them into a fragile market.

The backstop worked. Weekly Fed purchases peaked in late March at about $350bn of Treasuries and $180bn of agency MBS, then slowed as conditions improved. The S&P 500 hit its low on 23 March, nearly 34% below its 19 February record, and was back at a record by 18 August. The 10-year yield, freed from forced selling, fell to a record closing low of about 0.5% on 4 August.

Swap-line borrowing peaked at $449bn in late May, mostly by the ECB and the Bank of Japan, and the FIMA facility was made permanent in July 2021. The leverage hasn’t gone away: Fed researchers have kept tracking hedge funds’ Treasury futures and repo positions in the years since. A safe asset is only as safe as the market’s capacity to absorb sales.