Who caused this week's "US Treasury bond storm", "hedge funds, Japan, and even China"? Citigroup reveals the real reason.

This week, the US Treasury yields continued to rise, and the US bond market experienced its most challenging liquidity event since the banking crisis in March 2023 and the 2020 pandemic. On one hand, both bond auctions since the beginning of the year have not met expectations, resulting in a significant increase in bond yields. Hedge funds reducing their positions indicate market concerns about interest rates intensifying. On the other hand, weak demand from the international market and the risk of some countries reducing their holdings of US bonds have also made investors uneasy. Citi's Jabaz Mathai team pointed out in a research report on the 11th that although there has been selling in the bond market, there are no obvious signs of pressure on futures spreads. The real interest rate of TIPS has dropped more than the nominal interest rate. From April 2 to April 9, foreign official holdings of US bonds even increased by $30 billion. This means that this week's market turmoil is more likely caused by a "buyer strike" due to market concerns about a decrease in demand for US Treasury bonds, rather than actual selling behavior by foreign investors. The US Treasury market experienced a "buyer strike" in 2023, which was eventually alleviated through a joint statement by the Treasury and the Fed. In order to prevent a similar situation from recurring, Citi has proposed four potential solutions, including exempting the supplementary leverage ratio, halting quantitative tightening, adjusting bond repurchase programs, and canceling 20-year bonds. What happened? Demand shock and market turmoil, bond market "put options" This week, the US Treasury market experienced one of the most severe liquidity events since the banking crisis in March 2023. The auction performance of 3-year, 10-year, and 30-year bonds was poor, with the 10-year bond losing its hedge function earlier in the week and rising as the stock market fell. The poor performance of the 3-year bond auction on Tuesday led to pressure on the 10-year bond auction on Wednesday, and the 30-year bond auction on Thursday also faced significant pressure. Citi stated that the market's response to this turmoil was multifaceted. Swaps spreads have fallen significantly, the yield curve has steepened significantly, and the real yield of inflation-protected securities (TIPS) has fluctuated significantly. Another significant phenomenon this week is that the Trump administration delayed the implementation of tariff policies. Citi believes that the government may be concerned that an increase in Treasury yields will increase interest payments over the next decade, so some tariffs were postponed when the Treasury yield approached 4.5%. Why did this happen? The market generally speculates that some countries may reduce their holdings of US Treasury bonds due to US tariff policies. However, through an analysis of the data on foreign official holdings in the Fed's custody accounts, Citi found that from April 2 to April 9, foreign official holdings of US Treasury bonds increased by $30 billion, indicating that foreign investors may not have sold off US Treasury bonds on a large scale. Furthermore, despite selling in the bond market, there are no obvious signs of pressure on futures spreads. "For example, the net basis for 10-year Treasury futures has remained relatively stable amid the volatility this week, and compared to the sharp fluctuations during the 2020 pandemic, the current basis level is relatively mild." This indicates that futures market traders are not overly panicked by the selling in the bond market, and the pricing mechanism of the futures market is still functioning normally. In this selling, the real interest rate of TIPS dropped more than the nominal interest rate. Citi believes that this is not only due to increased expectations of economic slowdown but also because liquidity premiums are rising. This means that the adjustment of market inflation expectations is not just based on changes in economic fundamentals but also reflects market concerns about liquidity. Therefore, Citi believes that this week's market turmoil is more likely caused by a "buyer strike" due to market concerns about a decrease in demand for US Treasury bonds, rather than actual selling behavior by foreign investors: "This increases the likelihood of a purely buyer strike due to concerns about declining UST demand at the back end and is probably driven by increased volatility in risk assets." So, what can the US do? A buyers' strike refers to investors refusing to buy certain assets due to uncertainty about market prospects or policies. The buyers' strike in 2023 lasted for months and was eventually ended through a joint statement by the Treasury and the Fed. But what tools do the Fed and Treasury currently have that they can use? Citi has proposed several possible solutions: First is an SLR (supplementary leverage ratio) exemption. Exempting Treasury and reserve holdings from SLR requirements may be the simplest solution and could help improve dealers' intermediation ability, especially in the front-end market. Second is to stop quantitative tightening. If QT is stopped, the Fed will buy around $150 billion of old Treasury bonds per month, which would help stabilize the market. Third is to adjust the bond repurchase program. The Treasury could introduce a "guaranteed" repurchase program for old bonds to address market turmoil. Fourth is to cancel the issuance of 20-year bonds. Given the current imbalance of supply and demand, canceling the issuance of 20-year bonds is reasonable and would help support the yield spread of long-term bonds. This article is reprinted from "Wall Street Observer", author: Zhang Yaqi; GMTEight Editor: Yan Wencai.