Treasury Market Strains Emerge as Fed’s Balance Sheet Runoff Disrupts 10-Year Note Trading

The $30.5 billion in failed trades on the newest 10-year Treasury note reveals cracks in the market’s plumbing. These settlement failures—the worst since November’s $42 billion auction—stem directly from the Federal Reserve’s quantitative tightening program. When the central bank took just $6.5 billion of the offering versus $14.8 billion in May, it choked off liquidity at precisely the wrong moment.

Repo markets screamed the warning first. Lenders effectively paid borrowers to take the security, with rates turning negative. This wasn’t typical year-end volatility—it was a structural shortage. The Fed’s shrinking SOMA holdings, now down to $22 billion in maturing debt, removed the cushion that normally prevents such breakdowns.

Traders hoping for relief at December’s reopening got the opposite. The ‘specialness’ in repo markets became acute, suggesting deeper collateral scarcity ahead. With the Fed still draining $95 billion monthly from its balance sheet, these stresses may foreshadow more Treasury market dysfunction.