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Treasury Inconvenience Yields during the COVID-19 Crisis

Author

Listed:
  • Zhiguo He

    () (University of Chicago - Booth School of Business; NBER)

  • Stefan Nagel

    () (University of Chicago - Department of Economics; NBER)

  • Zhaogang Song

    () (The Johns Hopkins Carey Business School)

Abstract

In sharp contrast to most previous crisis episodes, the Treasury market experienced severe stress and illiquidity during the COVID-19 crisis, raising concerns that the safe-haven status of U.S. Treasuries may be eroding. We document large shifts in Treasury ownership during this period and the accumulation of Treasury and reverse repo positions on dealer balance sheets. To understand the pricing consequences, we build a model in which balance sheet constraints of dealers and demand/supply shocks from habitat agents determine the term structure of Treasury yields. A novel element of our model is the inclusion of levered investors’ repo financing as part of dealers’ intermediation activities. Both direct holdings of Treasuries and reverse repo positions of dealers are subject to a regulatory balance sheet constraint. According to the model, Treasury inconvenience yields, measured as the spread between Treasuries and overnight-index swap (OIS) rates, as well as spreads between dealers’ reverse repo and repo rates, should be increasing in dealers’ balance sheet costs. Consistent with model predictions, we find that both spreads are large and positive during the COVID-19 crisis. We further show that the same model, adapted to the institutional setting in 2007-2009, also helps explain the opposite signs of repo spreads and Treasury convenience yields during the financial crisis.

Suggested Citation

  • Zhiguo He & Stefan Nagel & Zhaogang Song, 2020. "Treasury Inconvenience Yields during the COVID-19 Crisis," Working Papers 2020-79, Becker Friedman Institute for Research In Economics.
  • Handle: RePEc:bfi:wpaper:2020-79
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    3. Hüser, Anne-Caroline & Lepore, Caterina & Veraart, Luitgard, 2021. "How do secured funding markets behave under stress? Evidence from the gilt repo market," Bank of England working papers 910, Bank of England.

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    More about this item

    Keywords

    Repo; safe asset; Treasury; habitat; dealer; yield curve;
    All these keywords.

    JEL classification:

    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty
    • G2 - Financial Economics - - Financial Institutions and Services

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