By Michael S. Derby
NEW YORK (Reuters) – Federal Reserve Bank of Dallas President Lorie Logan said Friday the U.S. government bond market remains vulnerable to significant shocks and that government authorities must push forward on creating a more formal system to help the market in times of trouble.
“The U.S. financial system has become increasingly vulnerable to core market dysfunction because the supply of intermediation has not kept pace with demand as the Treasury market’s size and complexity have grown,” Logan said in the text of a speech to be delivered to an event held by the University of Chicago Booth School of Business.
She pointed to a rapid expansion of U.S. government debt and a change in who buys and holds that debt, as well as the fading back of the large banks that once dominated the government bond market, as helping drive up vulnerabilities to major shocks.
When a shock arrives that rises to the level where it could threaten the basic functioning of markets, it is appropriate for authorities to take action, as they have in the past, Logan said. She pointed to the Fed’s intervention to both borrow and then buy massive amounts of government debt at the start of the coronavirus pandemic three years ago as a key chapter in authorities action to save a failing market.
Logan, who holds a vote on this year’s Federal Open Market Committee monetary policy meetings, did not comment on the outlook for monetary policy and the economy in her prepared remarks.
Before joining the Dallas Fed last year as its leader, Logan was a key official at the New York Fed designing and implementing the monetary policy directives of the FOMC. She spoke amid ongoing concern about how financial markets, most notably the sector that trades U.S. government debt, will respond to the next chapter of stress.
Those anxieties have been heightened by the aggressive pace of Fed rate rises done to counter very high levels of inflation. Those increases coupled with the Fed’s ongoing efforts to shed bonds to reduce its market footprint, have raised questions about what authorities might do to support markets in the future. A paper this week from the New York Fed said the official sector needs to move toward finding a more formalized approach to providing support.
“Central banks should rarely intervene to support the functioning of core markets, but when such interventions are needed, they must be effective,” Logan said, while adding in practical terms interventions, such as bond buying, can help in one way but then cause problems on other fronts.
Logan said authorities are continuing to work on methods to formalize how they might intervene and to shore up underlying market strength. She said it was critical that any efforts be clearly communicated and understood, and should the Fed need to buy bonds to shore up the market, that it be clearly marked as a support operation and not for monetary policy purposes.
“The public and private sectors must work together to enhance market resilience so that these episodes will be far less frequent going forward,” Logan said. Authorities should also “be prepared for those rare occasions when extreme stresses in core markets threaten financial stability or the macroeconomy” and “central banks must continue to develop the toolkit for mitigating dysfunction.”
(Reporting by Michael S. Derby; Editing by Andrea Ricci)
