Treasury working on bond market reforms, Yellen says

The Treasury Department is working on reforms for the bond market, which is reflecting increased uncertainty about the economic outlook, Treasury Secretary Janet Yellen said Monday.

The market for U.S. bonds, the yields of which have been rising along with interest rates and the strength of the dollar relative to other currencies, is experiencing higher transaction costs and lower liquidity levels, Yellen said, describing the bond market as the “bedrock of the global financial system.”

“We want to make sure that going forward our Treasury markets remain deep, liquid and well-functioning,” she said at an event in New York City. “We are working actively to try to bolster the functioning of that market to carefully look at what might be appropriate. I think the ability of broker-dealers to intermediate that market — their capacity has not grown in line with the size of the market. So we’re looking at a number of ways to improve resilience.”

“The SEC [Securities and Exchange Commission] is looking at initiatives in central clearing,” she added.

The attention from Treasury comes as yields for the 10-year U.S. bond have been shooting up, rising to 4.2 percent from 1.6 percent at the beginning of the year. Analysts say this is due to interest rate hikes coming from the Federal Reserve seeking to stamp out inflation, which has been more than 8 percent for seven months in a row.

High inflation and rising interest rates have resulted in huge swings in stock markets over the past few weeks. The Dow Jones Industrial average has bounded upward more than 9.5 percent since the end of September, but is still down almost 14 percent on the year.

All the volatility has led to concerns about the fundamental stability of the highly connected global financial system, which has been rattled in recent months by factors ranging from lockdowns affecting labor markets in Asia to failed policy implementations in the United Kingdom.

“To date, the U.S. financial system has not been a source of economic instability,” Yellen said Monday. “While we continue to watch for emerging risks, our system remains resilient and continues to operate well through uncertainties.”

Yellen also warned about potential issues in the so-called shadow banking system, a term that refers to financial institutions that act as money lenders without being classified as banks.

“We are also attentive to the possibility that higher market volatility could expose vulnerabilities in nonbank financial intermediation,” she said in her prepared remarks. “Since I arrived at Treasury, financial regulators have been working together to better monitor leverage in private funds and develop policies to reduce the first-mover advantage that could lead to investor runs in money market funds and open-end bond funds.”

The United Nations also warned about nonbank financial institutions in a recent report from its Conference on Trade and Development.

“Non-bank financial intermediaries carry out many of the same fundamental functions as regulated banks, yet they remain unregulated. The universe of non-bank financial institutions and credit providers, known as a shadow banking system, came under the spotlight during the GFC [global financial crisis],” the group said in its report.

“Largely unnoticed until then, the vast network of unregulated credit intermediaries, their opaque connectivity to the official banks and the hidden risks of such connections were at the epicentre of the global financial implosion,” the U.N. report said, noting that the 2008 crisis started in the relatively isolated segment of the U.S. mortgage market but spread quickly through shadow banking channels due to hedge fund speculation.