# Here’s what the Fed can do to keep bond rates from rising, says analysts

During the early days of the pandemic, regulators allowed banks that act as brokers, or middlemen, in the roughly $20 trillion Treasurys market to exempt U.S. government bonds from being treated as assets in calculations of the so-called Supplementary Leverage Ratio (SLR). It was one of many measures financial watchdogs deployed in recent years to prevent Wall Street from seizing up and to encourage banks to maintain the flow of credit to households and businesses.

See: Markets set up for disappointment from Fed meeting as bond yields renew rise

“If the SLR is not extended, the concern is we’ll see financial institutions dump a chunk of their U.S. Treasury exposure, which would see yields spike and send short-term shock waves through markets,” wrote Chris Weston, head of research at Pepperstone.

Under the current leverage rules, banks must have capital equal to at least 3 percent of their assets, with that share rising as high as 5% for large banks, the so-called systematically important financial institutions.

According to some market participants, the exemption would encourage banks to increase their holdings of Treasurys at a time when investors have grown increasingly concerned about the U.S. government bond market’s ability to handle periods of sharp volatility. More pertinently, it could help cap long-term bond yields that have risen to their highest levels in a year.

The 10-year Treasury note yield
TMUBMUSD10Y,
1.612%
is down 3.3 basis points to 1.602%, after finishing on Friday at the highest level since Feb. 2020. Bond prices move inversely to yields.

It’s unclear whether the Fed will use this week’s meeting of its rate-setting committee as the occasion to announce an extension of its capital relief measures, as the central bank has plenty of time before the March 31 deadline, when the exemption lapses. Still, the meeting could hold clues to the Fed’s stance on the issue.

Read: Fed to stay dovish this week as Powell channels his inner Gary Cooper calm

“The Fed has punted on the SLR extension question so far, but again, we will be looking at the press conference – to see if Powell is pushed on this and what his attitude is,” said John Velis, FX and macro strategist for BNY Mellon, in a Monday note.

At the same time, Fed Chairman Jerome Powell likely faces political pressure in terms of not cutting banks any more slack. Democrat senators Elizabeth Warren and Sherrod Brown have said an extension of the SLR exemption would amount to a “grave error,” representing a rollback of the regulatory regime that has strengthened the robustness of bank balance sheets, after several major storied institutions collapse at the onset of the 2008 financial crisis, while a string of others required bailouts.

Already, there are some signs that banks may be anticipating that further regulatory relief will not arrive.

The most recent data on the holdings of primary broker-dealers at banks, which trade directly with the Fed and U.S. Treasury, showed a record weekly decline in their U.S. government bondholdings to $185.8 billion.

Yet, despite the hubbub over the SLR rules, there also have been plenty of skeptics about whether an extension of the capital relief would be as meaningful to the bond market, as some had made it out to be.

Mark Cabana, head of U.S. rates strategy at BofA Global Research, dubbed the issue a “red herring.”

He noted that many market participants may be giving too much weight to the SLR rules as an immediate driver of Treasurys trading. But he did see one place where phasing out the relief could potentially hamper the bond market down the road.

Without relief, banks may lack the capacity to resolve moments of indigestion in the Treasurys market, which has cropped up somewhat of an issue as investors shed government debt throughout this year.

“For most investors, this is potentially a cause of market indigestion, not a major risk to positioning,” said Lauren Goodwin, economist and portfolio strategist for New York Life Investments, in an interview.

Read: Here’s what one hedge fund trader says happened in Thursday’s bond-market tantrum, which sent the 10-year Treasury yield to 1.60%