GM. This is Milk Road Macro, the newsletter that’s as strategic as a chess grandmaster’s next move—because this week, the Fed might just rewrite the rules on how banks handle US debt, and that could shake up everything.
Here’s what we got for you today:
- ✍️ Fed plans bank rule changes to absorb rising US debt
- 📊 What is your preferred main source of financial news?
- 🍪 Israel Prime Minister Netanyahu confirmed a truce with Iran
Prices as of 8:00 AM ET.
FED PLANS BANK RULE CHANGES TO ABSORB RISING U.S. DEBT
While everyone else is focused on the Middle East.
We’re focused instead on the Fed’s next liquidity trick.
It’s not that what’s happening in Iran isn’t important, of course it is.
But as we said last week, we think this is only a speed bump, rather than a systemic long-term issue.
Speaking of systemic long-term issues, the US Government’s ever-growing debt pile passed the $37 trillion mark last week.
And there’s a lot more debt to come, if President Trump’s deficit-widening “Big Beautiful Bill” is passed.
Somebody needs to buy the debt.
And it looks like the newest trick in the bag of tricks might be attempting to shove more debt onto the balance sheets of commercial banks.
This could be achieved through a change to the Supplementary Leverage Ratio (SLR).
(It sounds boring - but it could actually be very important)
I previously wrote about an SLR adjustment as one of three “sneaky liquidity tools” available to policymakers.
And now the Federal Reserve will meet to discuss changes to the SLR this week.
So, what in the world is the SLR?
Why might an SLR adjustment be such a big deal?
And what might it mean for risk assets like stocks and bitcoin?
Let’s take a look…
What’s the SLR?
The Federal Reserve will consider plans to ease leverage requirements (SLR) on large banks at a special meeting on June 25.
So what’s the SLR?
It’s a simple capital measure designed to prevent too much leverage.
The Global Financial Crisis (2008) exposed blind spots in the banking system.
Before the crisis, banks simply piled in on assets that looked “safe” under risk-weighted frameworks - think AAA-rated mortgage-backed securities.
But when those collapsed in 2008, capital buffers were exposed as inadequate and we saw a global financial market meltdown - ever seen the movie “The Big Short”?
After 2008, regulators decided that this can’t happen again, so we saw a raft of new regulations being applied to the banking sector.
One of those regulations was the SLR.
It ensures banks must hold capital against an asset regardless of its perceived “riskiness”, and that includes so-called “risk-free” Treasuries.
As far as the SLR is concerned, US Treasuries are just as risky as a mortgage-backed security or even shares of NVIDIA.
So, why adjust the SLR?
The SLR has increasingly become a hindrance for banks holding so-called “safe” assets, like Treasuries, because it imposes costs on trading these assets.
In times of Treasury market stress, banks currently aren’t positioned to respond - not because they don’t have the capital, but because of how capital rules are structured.
The current SLR disincentivizes banks from holding Treasuries.
At a time when the US is running historic wartime-like deficits, and foreign buyers are retreating from the Treasury market, liquidity is showing signs of cracking.
In February, Federal Reserve Chair Jerome Powell said he was “somewhat concerned about the levels of liquidity in the Treasury market”.
An adjustment to the SLR would allow commercial banks the ability to absorb more Treasuries.
It would increase the balance sheet capacity of banks, potentially by several trillion dollars.
Some people have a rgued that an SLR adjustment could be like unleashing a wave of “bank-led Quantitative Easing”.
This is a stretch.
It’s important to note tha t a change to the SLR will not force commercial banks to hold more Treasuries.
It will simply give them the “regulatory space” to do so.
There’s still risk in holding so-called “risk-free” Treasuries.
Banks may not want to pile in on more Treasuries.
However, the next potential step might be the Government “heavily leaning” on banks to take on more Treasuries, or maybe even mandating them to do so.
This isn’t a new thing - this has happened time and time again throughout history across many countries.
One of the most common solutions to a big Government debt problem is to just push more and more of the debt onto commercial banks.
Why is this particularly important now?
It’s no coincidence that this SLR talk is occurring now.
There’s a flood of new Treasuries coming.
This is due to the dynamics around the US Government’s “debt ceiling”.
The Government has recently spent more than $400bn from its “savings” - a huge pile of cash called the Treasury General Account (TGA).
But once the debt ceiling issue is resolved (which will be in the coming months), the Government will be flooding the market with bucketloads of new debt to refill the TGA.
Hundreds of billions of dollars will be needed over several months to refill the TGA.
During the previous two “TGA rebuilds”, 10-year Treasury yields rose by 180bps and 150bps.
The US Government will be worried about another spike in yields.
Surging Treasury yields can often have spillover effects to risk asset markets.
In recent years, 10-year yields rising above roughly 4.5% has coincided with weakness in US stocks.
Adjusting the SLR would mean banks have the ability to take on more Treasuries, just as a flood of new Treasuries hits the market.
This may help to put downward pressure on Treasury yields, if banks do step in to buy the debt.
Treasury Secretary Scott Bessent previously cited estimates that tweaking the SLR could reduce US Treasury yields by tens of basis points.
“We can see more bond buying by US institutions”, he said.
Wrapping up
The US Government needs to issue a lot more debt in the coming months and years.
It also needs to refill the TGA in the coming months.
This incoming wave of new Treasuries could potentially be destabilizing to the Treasury market, putting upward pressure on yields (which can be a bad thing for risk asset prices).
However, an adjustment to the SLR would allow commercial banks the ability to absorb more Treasuries.
Always remember, policymakers are on standby to use whatever tools necessary to boost liquidity.
Always be on your guard for “sneaky liquidity tools”!
That’s it for this edition - catch you for the next one.
POLL OF THE WEEK 📊
Last week, we asked you what you did when the Middle East conflict began.
Many of you sat on your hands and did nothing.
Some of you took advantage of the dip, buying crypto, stocks and gold.
While a small percentage of you sold.
Appreciate your responses last week! Now, onto this week’s poll:
How are you playing the current uncertainty in the markets?
- I think markets are mostly up from here
- I'm optimistic but waiting for confirmation that we're in the clear
- It's going to get worse before it gets better
BITE-SIZED COOKIES FOR THE ROAD 🍪
Israeli Prime Minister Netanyahu confirmed a truce with Iran. He said his country had achieved its war goals.
President Trump reiterated his desire for lower interest rates. He said rates should be “lowered by at least two to three percentage points” as Fed Chair Powell prepares for testimony in Congress today.
Trump arrives at the NATO Summit to secure record defense spending from allies. This year’s summit is poised to set a defense spending target of 5% of GDP for each member country.
MILKY MEME 🤣
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