The United States' $50 trillion debt is not only expanding but also testing the limits of the system that supports it

As the scale of U.S. debt approaches the $50 trillion mark, the pressure on the gatekeepers of U.S. Treasury bonds, the "primary dealers," is also increasing.

Primary dealers are an elite group composed of Wall Street institutions, established in 1960 by the Federal Reserve Bank of New York, aimed at ensuring the smooth operation of the U.S. Treasury bond market. Currently, this system has developed to a scale of nearly $29 trillion.

On December 31, according to primary dealers quoted by Bloomberg, "We are facing increasing pressure in fulfilling our responsibilities."

Moreover, the market is facing a key risk: If repurchase rates unexpectedly surge again and dealers are unable to intervene, hedge funds may not have properly considered this risk, leading to rapid and severe deleveraging, which could ultimately prompt the Federal Reserve to intervene.

U.S. Debt Expansion "Unstoppable," Primary Dealers Face "Many Difficulties" in Performing Duties

Primary dealers have stated that it has become increasingly difficult for them to fulfill their responsibilities in bidding for new debt in regular Treasury auctions and maintaining an active secondary market, partly due to the capital and leverage constraints imposed after the 2008 financial crisis.

Post-financial crisis regulations have increased the cost for bank-affiliated dealers to hold government debt and weakened their market-making ability, thereby promoting "market liquidity shortages" during turbulent times.

In addition to regulatory constraints, other pressures are also beginning to emerge. In key short-term financing markets, the intervention capacity of bank-affiliated dealers is limited due to balance sheet constraints, leading to periodic surges in key overnight rates. This situation occurred in 2019, and similar circumstances have arisen this September and now at the end of the year.

In September of this year, overnight repurchase rates briefly reached 5.9%. Now, overnight rates have climbed to between 4.25% and 4.5%, outside the Federal Reserve's target range for policy rates, and even with the Fed adjusting some tools for intervention this month, this situation still occurred.

Casey Spezzano, head of U.S. client sales and trading at NatWest Markets, stated, "Over the past decade, the issuance of Treasury bonds has nearly tripled, and it is expected to nearly double to $50 trillion in the next decade, while dealers' balance sheets have not grown at the same scale."

"You are trying to push more Treasury bonds through the same pipeline, but these pipelines have not gotten bigger."

However, it is not only primary dealers; many investment firms and former senior policymakers are also concerned that the U.S. Treasury market may repeat the "sell-off collapse" seen at the beginning of the pandemic.

Regulators Seem Unable to Stop U.S. Borrowing, Dealers' Holdings of Treasury Bonds Reach Historical Highs

Research from the U.S. Treasury Borrowing Advisory Committee shows that the intermediation capacity of primary dealers (measured by the total positions and financing of Treasury bonds as a percentage of the total market circulation) has steadily declined over the past decade, and if the current trend of surging U.S. debt continues, this capacity will further decline It is worth noting that regulators seem unable to control the pace of borrowing in the United States. Some analysts predict that the speed of borrowing in the United States will grow exponentially in the coming years, which could put pressure on primary dealers. For them, the question boils down to whether they can keep up with the surge in Treasury sales.

According to the latest data from the New York Federal Reserve, the amount of U.S. Treasury securities held by primary dealers has reached a historic high of nearly $400 billion. In 2014, the average holding by dealers was $43 billion.

Laura Chepucavage, head of global financing and futures at Bank of America, stated that the current rising debt, combined with regulatory considerations for dealers, makes the system inflexible and increases the likelihood of market turmoil. She said:

“From the perspective of liquidity provision, in the past, people could move to where they were needed, but now there are more considerations about how to trade and how to mediate in the market. We must be able to prepare in advance and withstand market turmoil.”