December ten-year U.S. Treasury bond "delivery failure" surged

Federal Reserve data shows that the failure to deliver ten-year U.S. Treasury bonds has surged to its highest level in eight years this month, primarily due to the Fed's ongoing reduction of its balance sheet since 2022.

As of the week ending December 10, the total amount of failed trades involving the latest issuance of ten-year U.S. Treasuries reached $30.5 billion, setting a new high since December 2017.

During the same period, the repo rate for this type of Treasury bond fell into negative territory, with holders willing to lend bonds at negative rates, and borrowers agreeing to sell them back at a lower price the next day—this abnormal situation often leads to a higher incidence of delivery failures.

The bond shortage is partly due to a significant reduction in the Fed's holdings during the November auction. Compared to earlier ten-year Treasury auctions this year, the Fed's holdings have noticeably decreased, while the Fed typically lends its securities to the market to alleviate supply tightness.

Jason Schuit, president of South Street Securities, a brokerage specializing in Treasury bond repos, pointed out that in the ten-year Treasury bonds auction in November, the quantity purchased by the Fed was only half of that in the previous three cycles, "the amount available for borrowing is just less," leading to supply shortages and delivery failures.

Fed's Balance Sheet Reduction Cuts Market Supply

In the November ten-year Treasury auction, $42 billion was sold to investors, with the Fed only applying for an additional $6.5 billion to replace maturing debt.

In contrast, in earlier quarterly auctions of the same size of $42 billion this year, the Fed's additional purchases were: $11.5 billion in February, $14.8 billion in May, and $14.3 billion in August.

This decline is due to the reduction in the size of maturing bonds in the Fed's System Open Market Account (SOMA). The SOMA holdings maturing on November 15 were slightly below $22 billion, while the maturities on February 15, May 15, and August 15 ranged between $45 billion and $49 billion.

The Fed began implementing a balance sheet reduction policy in mid-2022, only reinvesting when maturing Treasuries exceed the monthly cap.

This cap has been raised from $30 billion per month in June to $60 billion in September. As a result, the additional purchase amount for the three-year Treasury bonds maturing this year in the November auction decreased compared to previous quarters, leading to a reduction in additional purchases in last month's auction.

Treasuries held by the Fed are typically available for market borrowing, and the decrease in its holdings directly reduces the supply of borrowable bonds. Jason Schuit stated:

For this specific ten-year Treasury bond, the Fed's purchase amount is half of that in the previous three cycles. This has caused a supply shortage, which in turn leads to delivery failures.

Analysts believe that the Fed's balance sheet reduction policy has a substantial impact on secondary market liquidity, and investors are facing increasing operational difficulties during the bond settlement process