Treasury Markets and Financial Intermediation

We study what makes the Treasury market resilient: how far yields must move before investors absorb shocks. The paper asks how resilience depends on the marginal holder, maturity, shock persistence, foreign demand, arbitrageur capacity, and Federal Reserve balance-sheet policy. The analysis shifts attention from the total quantity of debt to the market structure and policy design that determine who absorbs Treasury-market stress.

We document a regime change in the Treasury market post-Global Financial Crisis (GFC): dealers switched from net short to net long Treasury bonds. We construct “net-long” and “net-short” curves that account for balance sheet and financing costs, and show that actual yields moved from the net short curve pre-GFC to the net long curve post-GFC. Our theory shows the regime shift caused negative swap spreads and co-movement among swap spreads, dealer positions, and covered-interest-parity violations. Furthermore, the effects of various monetary and regulatory policies are regime-dependent. We highlight Treasury supply as a plausible driver of this regime shift.

Different investors absorb different parts of Treasury supply, and arbitrageurs connect those segments. We estimate sector-by-maturity Treasury demand and embed it in a model with risk-averse arbitrageurs. The results show that Treasury-market elasticity is much higher at the short end than at longer maturities because T-bill arbitrage is safer. Cross-maturity substitution is also central for monetary-policy transmission: tightening raises term premia only when investors can substitute across maturities.

We demonstrate the passthrough of Treasury supply to bank deposits through bank market power. We show that a larger Treasury supply crowds out deposits with disproportionate effects in more competitive deposit markets. A larger Treasury supply further curtails bank lending and affects bank funding structure. The explanatory power of Treasury supply is not driven by other shocks to deposit demand and supply. In comparison, monetary policy rate hikes have a larger impact on deposit funding in more concentrated markets, consistent with the deposits channel of monetary policy. Our empirical findings are rationalized in a model of imperfect deposit competition.