Intermediary Balance Sheets and the Treasury Yield Curve

Abstract

We document a regime change in the U.S. Treasury market post-Global Financial Crisis (GFC): dealers switched from net short to net long Treasury bonds. Consistent with this change, we derive “net-long” and “net-short” Treasury curves that account for dealers’ balance sheet costs, and show that actual Treasury yields moved from the net short curve pre-GFC to the net long curve post-GFC. This regime change helps explain negative swap spreads post- GFC and the co-movement among swap spreads, dealer Treasury positions, yield curve slope, and covered-interest-parity violations, and implies changing effects for a wide range of monetary and regulatory policy interventions.

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