MNI INTERVIEW: U.S. Safe-Haven Status Under Pressure - Liang

A recent selloff in Treasuries signals a worrying erosion in the loss of safe haven status but doesn't appear to be driven by dysfunction, former Fed staffer and Treasury Department official Nellie Liang told MNI, adding persistent inflation raises the threshold for Federal Reserve intervention in markets. 

"This is to date not a market functioning issue. Market liquidity is a little worse, but markets are functioning," Liang said in an interview. "That would raise the bar for the Fed to intervene with purchases and it already has the Standing Repo Facility in place, which is a release valve put in place after" the March 2020 dash for cash episode.

"In my view, purchases because others don't want to buy Treasuries, versus because the markets are not working, is difficult and changes the rationale for a potential intervention. I think they would be much more careful about that," she said about the Fed. "We now also have inflation, versus in March 2020."

President Donald Trump's tariff policies are also likely to increase inflation but it could slow the economy, she said. "Tariffs will raise prices and inflation, and that's a different situation than what we were dealing with in 2020 when we were trying to get back up to 2% inflation and the economy was slowing. The Fed could (then) purchase and it was consistent with their monetary policy objectives," said Liang, who was at the Fed Board for over three decades, including as the first director of the Division of Financial Stability from 2010 to 2017.

"Right now, you could have a slower economy, but you're also going to have inflation, and so purchases would be in conflict with monetary policy objectives unless you thought the decline in output would be enough to suppress inflation. We're still above 2% and I think it's just a much harder call."  (See: MNI INTERVIEW: Fed Uneasy Over Optics Of Intervention-Kashyap)

SAFE HAVEN STATUS 

As investors dumped bonds last week, the surges in Treasury yields were amongst the largest ever seen. The moves echoed the wild price swings from the pandemic-induced sell-off in March 2020, but they were not the same. 

The cash futures basis trade "clearly was part of the March 2020 story. It is not a primary factor in this current episode," said Liang, who served as under secretary for domestic finance at the Treasury Department from 2021 to 2025. "We're not seeing those kinds of funding pressures." She noted that so far stability risks in the financial system are "ok." 

"The most important point is that it's not a repeat of March 2020, where there were a lot of leverage unwinds and redemptions from bond funds in the dash for cash," Liang said. "The funding pressures in this current episode are just not as significant."

"We should always expect market liquidity to deteriorate when you have such big increases in volatility. There is a significant positive correlation between volatility and market illiquidity," she added. "Treasury market liquidity has deteriorated somewhat, but maybe not too far out of line with expectations of volatility because of a reassessment of the outlook and also starting to question the value of the safe haven status of Treasuries."

"The dollar was the preeminent safe asset, the preeminent reserve currency. This is definitely at risk. How much it loses it's preeminent status as a safe haven is hard to assess right now. Maybe the US would be on more equal footing with some of the other safe assets. That's a loss to the U.S."

INTERMEDIATION CAPACITY

A well-functioning Treasury market nearing USD30 trillion is vital for the stability of the broader financial system, she said. Changes could be considered to the supplementary leverage ratio. (See: MNI INTERVIEW: US Bond Selloff A 'Stern Warning' To Fed -Stein)

One option is to exclude central bank reserves from the SLR calculation, but with an adjustment to the formula so that there would not be a reduction in the total amount of capital, Liang said. She does not advocate for excluding Treasuries, because they have interest rate risk. "While some adjustments may be appropriate, it would not change the fact that the amount of Treasury debt is much greater than what dealers could intermediate if there were a repeat of the surge of selling that we saw in March 2020."