[Economic Analysis] January U.S. Treasury Fails to Deliver (Fails) Data Analysis: A Warning Signal for Market Liquidity?

[Economic Analysis] January U.S. Treasury Fails to Deliver (Fails) Data Analysis: A Warning Signal for Market Liquidity?

Hello. I’m Seji, Senior Editor at SejiWork.

January, marking the start of a new year, holds more significance in financial markets than just being another month. It is a period when portfolios are rebalanced following year-end settlements and new liquidity flows are established. Specifically, 'Fails to Deliver (FTD)' data in the bond market—the very backbone of the macroeconomy—serves as a critical indicator that candidly reveals the underlying health of market liquidity.

Today, based on the primary 'Basic Figures on Fails' aggregated throughout January, I want to conduct a deep-dive analysis into the structural risk factors and the liquidity environment of the current financial market. For investors who prioritize asset management efficiency, this analysis will help clarify where invisible market pressures are heading.

Definition of January Fails to Deliver and the Macro Context

'Fails to Deliver' (FTD) refers to a situation where a securities trade has been executed, but the seller fails to deliver the underlying securities by the settlement date (T+1 or T+2). While these can occur due to simple operational errors, from a macroeconomic perspective, they often signal an 'extreme scarcity' of specific assets or a 'decline in collateral availability' within the financial system.

January Trends via NY Fed Data

According to Primary Dealer statistics published weekly by the Federal Reserve Bank of New York (NY Fed), the volume of Fails to Deliver for U.S. Treasuries and Mortgage-Backed Securities (MBS) in January showed significant volatility compared to the same period last year. Notably, a sharp spike in Fails for specific Treasury maturities was observed starting in mid-January. This is closely linked to the 'Squeeze' phenomenon, where the 'Repo rate'—the rate market participants pay to borrow specific bonds—drops sharply or even enters negative territory.

Data Analysis: Characteristic Indicators and Liquidity Shifts in January

The key takeaway from January’s Fails data lies more in the 'persistence of failures' than the 'total cumulative amount.' While routine operational errors are typically resolved within 1–2 days, some failures observed in certain segments during January persisted for several days beyond the settlement date.

Status of Fails by Asset Class

1. U.S. Treasuries

Fails occurred more frequently in long-term securities, such as 10-year and 30-year bonds, rather than short-term Treasury Bills. This suggests that while demand to use long-term bonds as collateral remains high, the available circulating supply is concentrated within specific institutions.

2. Agency MBS (Mortgage-Backed Securities)

As interest rate volatility expanded, settlement delays in the MBS market also rose. This suggests that bottlenecks occurred in the clearing process, coupled with prepayment risks of mortgage rights.

Correlation with the Repo Market

An increase in Fails to Deliver means it is extremely difficult to obtain those specific securities in the repo market. In mid-January, the 'Specials' phenomenon—where repo rates for specific bonds are significantly lower than the General Collateral (GC) rate—intensified. This shows that market participants were willing to pay high costs to secure specific bonds, a supply-demand imbalance that eventually cascaded into the Fails to Deliver figures.

Ripple Effects of Fails to Deliver on the Market

Rising Fails to Deliver is not merely a bookkeeping issue. It leads to increased costs and decreased efficiency across the entire market.

Liquidity Contraction and Increased Transaction Costs

When Fails become frequent, dealers widen their Bid-Ask Spreads to hedge against settlement risks. This ultimately leads to higher transaction costs for investors and results in a contraction of overall market liquidity. If this phenomenon becomes entrenched at the start of a quarter, like in January, it can negatively impact capital flows for the entire quarter.

Precursor to Systemic Risk

Historically, an explosive increase in Fails to Deliver has often foreshadowed liquidity crunches or collateral shortages at major financial institutions. While January's data hasn't yet crossed a critical threshold, the analysis that the central bank’s liquidity absorption—amid ongoing Quantitative Tightening (QT)—is reducing the flexibility of the settlement system is gaining traction.

Detailed Analysis of Key Features and Mechanisms

The Role of the Fail Charge

The U.S. bond market has a 'Fail Charge' system designed to discourage settlement failures. Typically, a penalty of '3% minus the Federal Funds Rate' is imposed. In the current high-interest-rate environment, this penalty cost might appear relatively low.

Advantages (Benefits)

• Market Self-Regulation: It discourages excessive short positions and encourages the physical delivery of securities.
• Transparency: The data helps visualize supply-demand bottlenecks in the market.

Disadvantages (Risks)

• Systemic Strain: If the charge loses effectiveness in high-rate environments, there is a risk of 'Chain Fails.'
• Operational Risk: Large-scale settlement errors hinder the capital efficiency of financial institutions.

SejiWork Professional Insight: How to Interpret January’s Data?

Currently, the Fed's monetary policy revolves around two pillars: maintaining high interest rates and Quantitative Tightening (QT). In this environment, the gradual upward trend in Fails to Deliver indicates that the 'velocity of collateral' within the financial system is slowing down.

Based on this January data, I believe we must prepare for the following three scenarios:

1. Intensifying Collateral Scarcity: Concentration in specific High-Quality Liquid Assets (HQLA) will strengthen, potentially leading to distortions in the Treasury yield curve.
2. Repo Market Volatility: As we approach quarter-end, liquidity shortages are likely to worsen, leading to repeated spikes in repo rates.
3. Policy Pivot Triggers: If Fails to Deliver surge to uncontrollable levels, the Fed may be forced to adjust the pace of QT or accelerate the adjustment of Reverse Repo (RRP) balances to stabilize the market.

Ultimately, the January figures are not just simple statistics; they are a yardstick for measuring the intensity of the pressure the Fed's tightening policy is exerting on the market’s infrastructure.

Conclusion and Future Outlook

While January’s Fails to Deliver data does not yet signal a large-scale crisis, it clearly demonstrates that the liquidity soil has become much more barren than before. Investors should not just focus on interest rate levels; they must periodically check these invisible settlement data points and the flow of the collateral market.

An increase in Fails is a sign that market friction is growing. A machine with high friction can easily overheat from even a small shock. Now is the time for foresight—monitoring upcoming data for February and March to see if the market’s liquidity sources are functioning smoothly.

SejiWork will continue to analyze the data hidden behind the macroeconomy to deliver the fastest and most accurate insights. We will always be with you on your journey to cultivate an eye for market trends.

Thank you.