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Fed Ends Capital Break on Bank Treasury Bond Holdings; Yields Rise

The Fed said Friday it won't extend a capital break for banks that hold huge amounts of Treasuries, potentially triggering another rise in bond yields.

The Federal Reserve said Friday that the expiration of rules linked to banks holdings of Treasury bonds will go ahead as planned, potentially triggering a renewed rise on bond yields. 

The Fed's Supplementary Lending Ratio (SLR) rule, put in place last year to stabilize bonds markets during the peak of the pandemic-induced volatility, will expire on March 31. The rule allowed banks to stock up on Treasury bonds without the need to set aside excess capital to compensate for them.

"To ease strains in the Treasury market resulting from the COVID-19 pandemic and to promote lending to households and businesses, the Board temporarily modified the SLR last year to exclude U.S. Treasury securities and central bank reserves," the Fed said in a statement Friday. "Since that time, the Treasury market has stabilized. However, because of recent growth in the supply of central bank reserves and the issuance of Treasury securities, the Board may need to address the current design and calibration of the SLR over time to prevent strains from developing that could both constrain economic growth and undermine financial stability."

The Fed added separately that it will consider public comments on SLR adjustments after the March 31 expiry. 

Benchmark 10-year Treasury note yields edged higher immediately following the Fed statement and were last seen trading at 1.746%, just shy of the 1.75% level -- the highest since January 2020 -- reached during yesterday's trading session.

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U.S. stocks slumped lower, as well, with the Dow Jones Industrial Average giving back earlier pre-market gains to open 29 points in the red, with the S&P 500 down 16 points from last night's close

JPMorgan  (JPM)  shares slipped 2.5% lower, as well, following yesterday's all-time high of $161.69 each, to change hands at $153.75 each. 

Goldman Sachs  (GS)  shares were also on the back foot, falling 1% to $345.00 each.

Earlier this week, the Fed pledged to maintain its loose monetary policy for at least the two years, even as it boosted its GDP forecast and said inflation would likely rise past 2% in the coming months.

The moves, which effectively anchoring short-term bonds yields at near record lows while indicting a tolerance for inflation that has lifted longer-term yields to multi-year highs, gives banks some of the best financial conditions under which they operate in at least five years.