The U.S. Treasury market has recently experienced significant friction, influenced by the Federal Reserve's reduction of its Treasury holdings since 2022. The latest data reveals that settlement failures for the current 10-year U.S. Treasury note have surged this month to their highest level in eight years, highlighting a supply-demand imbalance for this key maturity in the repo market. Data from the New York Fed shows that for the week ending December 10th, the volume of failed-to-deliver transactions involving the newest 10-year Treasury note reached $30.5 billion, the highest since December 2017. This spike in settlement failures coincides with an unusual decline in the borrowing rate for this specific note. This batch of bonds originated from a $42 billion auction held on November 12th. In the repo market, some holders were willing to lend at negative rates, with borrowers agreeing to sell them back the next day at an even lower price—an environment where settlement failures are more likely to occur.
Typically, it is not uncommon for a specific security to trade at a "special" rate in the repo market just before a Treasury reopening auction, as the new supply is not yet available. However, the scarcity of this particular 10-year note ahead of its December 15th reopening was notably "unusual." Industry insiders point out that a key reason is the significantly reduced amount of this note available for lending from the Federal Reserve's holdings. Jason Schuit, President of South Street Securities, stated, "There are demonstrably fewer Treasuries available to lend. For this 10-year note, the Fed's purchase in this cycle was only half of what it was in the previous three cycles, which directly created a supply shortage and led to these settlement failures."
Specifically, during the November 10-year Treasury auction, the Treasury Department sold $42 billion to private investors, while the Fed added only $6.5 billion to replace maturing debt. In contrast, during the previous three quarters, with similarly sized private market issuance, the Fed's additional purchases were substantially higher: $11.5 billion in February, $14.8 billion in May, and $14.3 billion in August. This change is directly linked to a significant drop in the maturity size of the Fed's System Open Market Account (SOMA). On November 15th, less than $22 billion in Treasuries matured within SOMA, whereas the corresponding amounts in February, May, and August ranged between $45 billion and $49 billion.
The decline in SOMA maturities stems from the quantitative tightening policy the Fed initiated in mid-2022, where it only reinvests proceeds when maturing Treasuries exceed a monthly cap. This cap was raised from $30 billion in June to $60 billion in September. Under this framework, the Fed's additional purchases at auctions have consequently decreased, thereby weakening the supply of lendable securities in the repo market. Market participants believe this case demonstrates that as the Fed continues to shrink its balance sheet, "structural tightness" for key maturity Treasuries in repo and settlement processes may occur more frequently, posing a new test for the stability of short-term funding markets.
