‘10-year Treasury Fails’? What Does That Mean?

Dec. 31—Bloomberg News of two days ago has set off a spate of follow-on stories about a “December surge in fails” of 10-year Treasury Notes; that is, cases where settlement of a trade of a 10-year Note fails because the seller or dealer cannot arrange timely delivery of the Note to the buyer. All agree that this signals a shortage of liquidity in the world’s largest financial market, the $31 trillion market for publicly held Treasuries. Analysts give different weights to two causes: quantitative tightening from May 2022 to October 2025; and the current Fed-Treasury agreement to load new debt with issues of very short-term Treasury Bills rather than Notes and/or Bonds—essentially, selling to shadow banks and speculators—while the Federal Reserve purchases $40 billion/month of those Bills.

One Wall Street website tried to be reassuring. “Importantly, the data do not necessarily [!] point to a breakdown in the Treasury market itself. Settlement fails can be driven by a range of factors, including increased short-selling activity, hedging flows, or sudden shifts in positioning [that is, hedge fund speculation—ed]. However, the scale of the recent increase suggests that tighter financial conditions are testing the limits of market infrastructure.”

Another factor, coming from the real world economy: Foreign governments held 40% of Treasury debt in the early 2010s; now they hold 15%. Their purchases accounted for almost half the sales of U.S. debt. The biggest change has been the absence of China from the market; The Chinese who once held almost $2 trillion in U.S. debt and were often the sole buyers in some sales, have more than halved their holdings. China, as was known both inside the markets, in general, and within government circles, was taking its huge trade surpluses and pouring them back into the U.S. through purchases of U.S. debt. The statements that trade with China was a "one way" street by U.S. government officials were always wrong to the point of being outright silly. 

Not only has China halted U.S. debt purchases, but they have also been selling off their U.S. debt, as they transition away from dollar holdings. These sales have the potential to disrupt, if not blow up, the whole Treasury market—if China wanted to do that, which they do not.

Meanwhile, a similar phenomenon has taken place with Japan, which also used to pour back trade surpluses into the U.S, debt market. Those purchases have also collapsed, as U.S. policy has contributed to a sharp decline in what used to be one of the world's healthier economies.

Without these big national players helping to make the market for U.S. debt, the troubles will continue and get worse. While some wealthy Arab oil nations, like Saudi Arabia, and the Emirates, have increased their U.S. debt purchases, they are no where near the level that China, and before it Japan were.

And among foreign countries, the biggest share of U.S. Treasury debt is held in what the Treasury categorizes as “financial centers”: the Cayman Islands, the British Channel Islands, Luxembourg, Monaco, etc.