Early in the pandemic, the Federal Reserve undertook one of the fastest quantitative easing campaigns in its then-107 year history, under conditions ostensibly necessitating such actions. But like all major government programs, unintended consequences are likely; we may be experiencing some early effects at present.

For both the US and the UK, inflation is taking a toll on sovereign (government-issued) bond markets. For several reasons, the typical purchasers of US Treasury bonds have been stepping away from the market. …

The biggest drop in demand has come from the Federal Reserve, which “plans to offload Treasuries from its balance sheet to $60 billion a month.” This transition, called the balance sheet “runoff,” constitutes a massive change in US monetary policy. For the past few decades, the Federal Reserve has been a major buyer of US Treasuries (and other instruments), and after essentially supporting that market for years, the reversal of the policy is being felt acutely. For conditions to remain as they were, the withdrawal of demand previously provided by the Fed must now be made up by other buyers. But high debt loads, rising inflation, and the slowing of growth globally has foreign governments and large international financial firms wary of buying US debt. As a result, Bloomberg reports that the “Bloomberg US Treasury Total Return Index has lost about 13 percent this year, almost four times as much as in 2009, the worst full year result on record for the gauge since its 1973 inception.” This has prompted some analysts to warn of an illiquidity spiral, in which “volatility creates more illiquidity, which leads to more volatility,” which in turn causes yet more illiquidity.

And this is not the first time waning interest in Treasuries has caused concern. Six months before anyone knew what COVID was, a crisis in the market for repurchase agreements (repos) had its roots in a similar dissipation of appetite for government securities.