The US Treasury has played down concerns over the soaring number of trade failures for US government bonds, which hit an eight-year high of $456bn in the week to March 9.
Trade failures, reported by big banks and brokers known as primary dealers, occur when a bank or investor agrees to lend or sell a Treasury security but then does not deliver it.
Data released on Thursday by the Federal Reserve Bank of New York show overall failures to deliver reaching $452bn for the week ending on March 16. The figures are usually below $100bn, and compare to an average of $94bn per week earlier in the year.
In the week ending on March 9 failures for the 10-year Treasury note climbed to their highest level since data collection began in April 2013, before falling back to more normal levels in Thursday’s release.
Market participants point to the combination of many factors to explain the severity of the increase in failures. The US Treasury said the main cause was the build-up to fresh issuance of benchmark 10-year notes and 30-year bonds, which settled on March 15. Dealers may oversell securities knowing that fresh supply is not far away, which can result in an uptick in trade failures. Despite the drastic increase the Treasury said there was nothing yet to worry about.
“It’s typical to see larger demand for Treasury collateral ahead of settlement dates and therefore to see fails rising into the settlement date,” said a Treasury spokesperson. “We don’t yet see reason to think there is anything too out of the ordinary here.”
However, some analysts and investors say that a slow and steady uptick in failed trades over the past few years is a consequence of the pressures on bank balance sheets.
Banks complain that increasing capital requirements makes them less willing to facilitate trading in US Treasuries, so it becomes harder for dealers and investors to find securities and trade failures increase.
“We have always had periodic, issue-specific increases in fails,” said Louis Crandall, chief economist at Wrightson ICAP. “This one was large but the upward march …we have seen over the past few years is a different phenomena and definitely worth keeping an eye on.”
The rise in failures also compounds fears over instability in the world’s largest government bond market. While the failed trades may not create too much disorder in the current, relatively calm environment, the concern is that in a time of stress, high fail rates could be more problematic.
Each failed trade incurs a penalty fine and would leave a counterparty facing another for payment, rather than holding the security they thought they had bought.
“When there is nothing ugly happening out there it is no big deal,” said Jason Prest, a treasury trader at III Capital Management. “But when prices are swinging wildly, the counterparties build large exposures to each other. That is exactly the opposite of what you want in that environment.”
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