Fueled by the warming expectations of a soft landing for the U.S. economy, U.S. Treasuries have reenacted the massive sell-off of 1995, triggering a global market resonance. Beyond these widely acknowledged market factors, what can we discern from a deeper analysis of the underlying logic behind the U.S. Treasury bond plunge from a capital perspective? Dallas Fed President Lorie Logan's speech on October 21 provided some crucial clues.

Bank of America Merrill Lynch's research report on October 22 offered a detailed analysis of Logan's speech, stating that Logan believes the sharp decline in U.S. Treasuries stems from the tightening market financing conditions caused by quantitative tightening, and the market must "tolerate normal, moderate, and temporary stress." If the aim is to improve market liquidity through the Federal Reserve's repurchase clearing mechanism, the current effects appear to be limited.

Additionally, Bank of America Merrill Lynch pointed out that Logan's speech seemed to have omitted a key point: if the debt ceiling is breached again, the balance of the Treasury General Account (TGA) would decrease, which is a critical signal for suppressing the financing market and would affect the market's confidence in U.S. Treasuries and other assets.

Logan: "Tolerate normal, moderate, and temporary stress" during the quantitative tightening process, especially with the ongoing growth in U.S. Treasury supply

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Logan stated that market liquidity remains very ample at present. Compared to the Investment Return Benchmark Rate (IORB), both the Transactional Government Cash Return (TGCR) and the Federal Funds Rate (FF) are at lower levels, reflecting an abundance of funds in the market, sufficient liquidity for investment, and low financing costs.

In response to the excessive market liquidity, the Federal Reserve is addressing the issue by reducing its balance sheet. During this process, Logan believes it is necessary to "tolerate normal, moderate, and temporary stress in the money market," meaning that financing costs will rise.

Furthermore, Logan believes that the lower Transactional Government Cash Return (TGCR) and higher Secured Overnight Financing Rate (SOFR) also reflect that, despite ample market liquidity, dealers still face some restrictions (possibly due to regulatory requirements), which also indicates the tension in the financing market. With the introduction of related regulations, these restrictions may become more pronounced.

In addition, the continuous growth in the supply of U.S. Treasuries is a core risk that cannot be avoided. Bank of America Merrill Lynch analysts mentioned that Logan implied that with the ongoing growth in U.S. Treasury supply, financing costs would also rise, leading to a decline in U.S. Treasury prices and an increase in yields.Logan: Limited Effect of Fed's Repurchase Clearing

If U.S. Treasuries continue to plummet and the market faces a liquidity crunch, can the Federal Reserve's repurchase clearing mechanism solve the temporary dilemma?

Logan suggests that while the Federal Reserve's repurchase clearing can help dealers more effectively manage the risk exposure on their balance sheets, better manage the repurchase cash borrowed from and lent to the Federal Reserve, and improve capital efficiency, it is unlikely to happen quickly. Logan believes there are two main obstacles: the Federal Reserve's counterparty risk considerations and the margin requirements of CCPs.

(Counterparty risk considerations: This refers to the risk that one party fails to fulfill its contractual obligations in financial transactions. For the Federal Reserve, as a central bank, its duty is to maintain financial stability, so it needs to strictly assess the credit status and market risks of participants.

CCP margin requirements: CCP stands for "Central Counterparty." It is a financial market infrastructure designed to reduce the credit risk between trading parties and enhance market transparency and efficiency. If the Federal Reserve chooses to engage in repurchase clearing with CCPs, market participants may face higher margin requirements, which could increase their financing costs.)

In this situation, the Federal Reserve's cautious attitude towards risk control may lead it to be reluctant to quickly advance repurchase clearing, which means that even if there is such a plan, it may take a longer time to actually implement it.

Moreover, even if the Federal Reserve implements repurchase clearing, participants may still need to seek cheaper U.S. Treasuries to reduce financing costs and manage risks when facing high margin requirements, which will further lead to a decline in U.S. Treasury prices.Bank of America Merrill Lynch: Logan Missed the "Key Point" - Government Debt Ceiling and TGA Balance

Bank of America Merrill Lynch also added that they believe Logan missed a key point (possibly due to political sensitivity), which is the lack of discussion on the U.S. debt ceiling, a significant factor affecting the financing environment at present.

Bank of America Merrill Lynch believes that if the debt ceiling is reached again, the government's cash flow will be affected, and the balance of the Treasury General Account (TGA) will decrease, which is a key signal to suppress the financing market.

The market usually adjusts its assessment and expectations of risk based on changes in TGA. If investors anticipate that financing conditions will become more strained, their confidence in certain assets (such as U.S. Treasuries) will also decrease as a result.

Logan's and other Federal Reserve officials' recent comments suggest that they are willing to continue QT during the debt ceiling period until financing pressures send a clearer signal, although this approach may lead to an unexpected sharp tightening of the financing environment during the TGA rebuilding period.