1 1 (July 20, 2020)

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               Researh Sevice

Treasuries and Repo in the Time of COVID-19

July 20, 2020

Background: Three Roles for Treasuries

The U.S. Treasury issues debt s ecurities-known as Treasuries-that play three critical roles in the
economy: funding the government, supplying safe assets, and anchoring liquidity flows in financial
markets. This Insight examines how the coronavirus pandemic has affected all three roles.
Treasuries primarily serve as a means of government finance. The U.S. Treasury sells securities to obtain
cash to fund government operations when revenues fall short of outlays. The Treasury issues bills,
maturing within a year, to respond to short-term financing needs. Treasury notes, with maturities up to 10
years, and bonds, with longer maturities, help the government hedge against the risk of rising interest
rates. Most Treasuries first sell in scheduled auctions and then trade in secondary markets.
Investors hand over cash to purchase Treasuries to obtain assets essentially free of default risk that serve
as a store of value as well as a safe haven against severe market or other unforeseen risks. Interest rate
changes affect the price of Treasuries. Longer-term Treasuries generally carry higher yields to induce
investors to lock up funds for longer times. The yield curve-a plot of Treasuries' yields ordered by their
maturities-therefore usually slopes upwards. Adownward sloping, or inverted yield curve can signal an
impending economic slowdown.
Treasuries anchor liquidity flows in financial markets largely through repurchase agreements, or repos. A
repo provides a common means of secured lending, often within the nexus of financing arrangements
involving nonbank financial institutions sometimes called the shadow banking ,ystem. Most repo trades
use Treasury securities for collateral, intertwining repos and markets for Treasuries. Repos allow asset
holders to obtain extra revenues on otherwise idle assets. Most U.S. repo lending is overnight, although
some repos continue on a rolling or open basis.
For instance, a hedge fund may sell $100 million in Treasuries to a bank for a day in return for $98
million in cash to fund its operations. The next morning, the hedge fund repurchases the Treasuries,
returning the cash and an interest charge to the bank. That $2 million difference-the hairut ------helps
protect the bank from credit and transactions risks. Haircuts for other types of assets are generally higher.
Asset holders and borrowers might also transact a repo through a clearing bank, called a triparty repo.
Hedge funds use repos for leverage by taking short positions on Treasuries-that is, lending borrowed

                                                                 Congressional Research Service
                                                                                       INI 1461

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