Will Banks Buy More Treasury Bonds?
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June 18, 2025 | This week, The Institutional Risk Analyst is in Grand Lake Stream Maine for the start of the 2025 fishing season. The weather is cold and rainy, which means perfect fishing conditions. The bass in West Grand Lake are hungry and in some waters still on their spawning beds because of chilly weather conditions this Spring. This means that we are going to have some fun with surface action today at the upper end of West Grand Lake, then lunch at General Jimmy Doolittle's cabin.
Of note, half a dozen wings, two amazing lobster roll baskets, and two drinks was $82 before the tip at the Harris Family food stand in Lee Maine, yesterday. A quarter century ago, when we first travelled to Grand Lake Stream, that meal cost around $25. What does this say about price stability in America â„… the national Congress and the Federal Open Market Committee?Â
Lee Maine
US bank regulators plan to reduce the enhanced supplementary leverage ratio (eSLR) by up to 1.5 percentage points for the biggest lenders, Bloomberg reports, which will lower leverage ratios and thus capital requirements. A number of clients ask whether this means that banks will necessarily buy more Treasury paper and/or mortgage backed securities. That depends.
Given modest loan demand and deposit growth in the industry, meager quantities of excess liquidity are chasing opportunities across the board, one reason that "other loans and leases" is the fastest growing bank asset line item. Banks finance primary dealers on an arm's length basis, let's recall. But new mortgage and MBS volumes are at 10-year lows.
Banks will hold incremental Treasury debt, but this is not the first choice because of the poor returns. To President Donald Trump's point about rate cuts, deposit rates and loan yields of US banks have been falling for two quarters, a topic we'll be discussing for our Premium Service subscribers in our next issue.
The big factor affecting whether banks buy Treasury debt will be when the FOMC ends "quantitative tightening" and starts to expand its holdings of government debt. As Treasury paper and MBS run off, the Fed of New York will reinvest in Treasury paper only mirroring the issuance by Treasury in terms of the distribution of maturities.
If the FOMC grows the balance sheet rapidly, then bank reserves and assets will grow, and depositories will have no choice but to own more Treasury paper over time. The impetus to own Treasury debt will increase if Congress takes away the Fed's power to pay interest on reserves, a move that makes a systemic event in the Treasury markets more likely.
The connection between expanding the balance sheet via open market purchases of Treasury debt and bank reserves is one of the starkest illustrations of how federal budget deficits translate directly into inflation. When you hear some facile economist say that the Fed can purchase Treasury debt without stoking inflation, remind them of the obvious. Tight lines.
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