What’s happening (in simple terms)

In December, there was an unusual shortage of the newest US 10-year Treasury bonds — the world’s most important benchmark bond. Because there weren’t enough of these bonds available, some trades failed to settle on time, hitting the highest level in eight years.

Normally, when investors buy or sell Treasuries, the deal settles smoothly. But this time, about US$30.5 billion worth of trades didn’t go through on schedule. This happened because too many investors wanted to borrow the latest 10-year bond — and there simply weren’t enough of them available.

Why was there a shortage?

The key reason is the Federal Reserve’s balance-sheet shrinkage, also known as quantitative tightening (QT).

Since 2022, the Fed has been allowing its bond holdings to run off instead of reinvesting fully when bonds mature. As a result:

• The Fed owns fewer Treasuries

• It has fewer bonds available to lend into the market

• This reduces supply and makes certain bonds scarce

In November, the Fed bought only US$6.5 billion of the new 10-year bonds at auction, far less than earlier in the year when it bought US$11–15 billion per auction. With fewer bonds held by the Fed, fewer were available for borrowing — creating a bottleneck.

Why did interest rates turn negative?

Because the bond was so scarce, investors were willing to pay a fee just to borrow it. In technical terms, repo rates went negative.

This means:

• Borrowers agreed to sell the bond back for less than they paid

• Lending the bond became more valuable than the interest earned

• Negative rates make settlement failures more likely, because the economics get distorted

Why this matters for markets

This isn’t just a technical issue — it has wider implications:

1. Market liquidity is being strained
   Delivery failures signal friction in the Treasury market, which underpins:

   • Global bond markets

   • Equity valuations

   • Mortgage rates

   • Currency markets

2. The Fed’s tightening is biting harder than expected
   By shrinking its balance sheet, the Fed is unintentionally:

   • Reducing market liquidity

   • Making benchmark bonds harder to trade

   • Increasing volatility in funding markets

3. Bond yields may become more volatile
   When supply is uneven and borrowing costs swing sharply:

   • Treasury yields can move unpredictably

   • Risk premiums may rise

   • Investors demand higher returns to hold bonds

What this could mean for the economy

• Higher borrowing costs
  Treasury yields anchor interest rates across the economy. Persistent disruptions could push up:

  • Mortgage rates

  • Corporate borrowing costs

  • Government financing costs

• Tighter financial conditions without rate hikes
  Even if the Fed stops raising interest rates, QT alone can tighten conditions — slowing investment and growth.

• Higher risk of policy adjustment
  If these problems spread, the Fed may be forced to:

  • Slow or pause balance-sheet reduction

  • Increase bond lending operations

  • Rethink how aggressively it shrinks its holdings

Bottom line

What looks like a niche bond-market issue is actually a warning sign. The Fed’s effort to withdraw liquidity is starting to stress the plumbing of the financial system. If shortages and settlement failures persist, markets could become more volatile — and the Fed may eventually need to step in to prevent broader disruption.

In short:
Less Fed buying → fewer bonds → market strain → potential knock-on effects for rates, stocks and the economy.

Thank you