Treasury Inconvenience Yields during the COVID-19 Crisis

Zhiguo He, Stefan Nagel, Zhaogang Song

NBER Working Paper No. 27416
Issued in June 2020, Revised in November 2020
NBER Program(s):Asset Pricing, Corporate Finance, International Finance and Macroeconomics, Monetary Economics

In sharp contrast to most previous crisis episodes, the Treasury market experienced severe stress and illiquidity during the COVID-19 crisis, raising concerns that the safe-haven status of U.S. Treasuries may be eroding. We document large shifts in Treasury ownership and temporary accumulation of Treasury and reverse repo positions on dealer balance sheets during this period. We build a dynamic equilibrium asset pricing model in which dealers subject to regulatory balance sheet constraints intermediate demand/supply shocks from habitat agents and provide repo financing to levered investors. The model predicts that Treasury inconvenience yields, measured as the spread between Treasuries and overnight-index swap rates (OIS), as well as spreads between dealers’ reverse repo and repo rates, should be highly positive during the COVID-19 crisis, which are confirmed in the data. The same model framework, adapted to the institutional setting in 2007-2009, also helps explain the negative Treasury-OIS spread observed during the Great Recession.

Acknowledgments

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Document Object Identifier (DOI): 10.3386/w27416