The Periodic Treasury Exchange: A Proposal to Increase the Depth and Liquidity of the U.S. Treasury Market

Abstract

In recent years, the liquidity of many fixed income markets has declined as banks have stepped away from their traditional role as market makers, triggering sharp market movements, as, for example, happened on October 15, 2014 when the yield of the 10 year Treasury experienced a 37 basis point trading range. Even though market making in the Treasury market is increasingly electronic, the balance sheets of many electronic market makers are not large enough to support significant positions, particularly in off-the-run securities. In this article, we propose a mechanism by which off-the-run treasury securities can be exchanged periodically for on-the-run treasury securities, allowing market participants to better hedge their books, and therefore to transact in significantly larger sizes without fear of disrupting the market or experiencing significant losses from a widening of the basis between near-offsetting long and short positions.

Keywords: Treasury Liquidity, Bond Exchange, Off-The-Run, On-The-Run

JEL Classification: D4, D40, D41, D44, D49