Higher federal deficits in the wake of the financial crisis required Treasury to increase the amount of issuance for some time, but the deficit has now shrunk to a level closer to historical norms, bringing the required level of additional issuance, also known as “net issuance,” down in tandem.4 However, gross issuance, defined roughly as the sum of the issuance required to refinance maturing debt and the net issuance required to fund the existing deficit, continues to be very high by historical standards. For example, in 2014, the U.S. Treasury issued just over $ billion on a net basis, whereas there was $ trillion in total gross issuance taking place over the year. A deep and liquid secondary market, where traders buy and sell existing securities at an agreed-upon price, is a crucial attribute of the asset class, and primary dealers and other market participants also play an important role here. Strong liquidity in the secondary market facilitates smooth price discovery and ensures that investors can adjust their holdings of Treasury securities at minimal cost. The attractiveness of Treasury securities to investors, in turn, helps minimize the cost of issuance to the U.S. Treasury and facilitates the Federal Reserve’s ability to implement monetary policy. The secondary market for Treasury securities operates on an over-the-counter basis – that is, not on an exchange.5 Historically, secondary market trading has fallen into two categories: trades between dealers and customers, and trades between dealers.
Traditional broker-dealers generally carry net long or short positions in Treasury securities from one day to another, an activity that requires capital. Dealers hold Treasuries for a variety of reasons, including to support the liquidity needs of their customers, to hedge exposure in other fixed-income products, and to meet their obligations as primary dealers to participate in U.S. Treasury auctions and the Federal Reserve’s open market operations. Many argue that the ability and willingness of dealers to  7  A CLOB protocol aggregates all executable bids and offers across participating liquidity providers in a single order book that is available to all market participants. In a liquid market, the continuous visibility of quotes and the interaction of multiple bids and offers are likely to enhance the price discovery process and market transparency. In contrast, a request-for-quote protocol, where a request for liquidity typically is submitted to only a limited set of providers, by its nature imposes a degree of market segmentation that may impede the price discovery process as compared with a CLOB protocol, but is arguably better suited to handle large block trades and illiquid securities. 8  Momentum detection is a strategy that attempts to predict short-run price changes based on patterns in realtime market data. Statistical arbitrage is a trading strategy that typically relies on identifying mean reversion from historical relative pricing relationships between correlated assets. Spread trading seeks to profit from a simultaneous purchase and sale of two closely related fixed-income assets.