Testing the Liquidity Support Effects of the U.S. Treasury Buyback Program

The U.S. Treasury’s recently introduced liquidity support buyback program offers a natural setting to evaluate whether providing a regular mechanism for selling less liquid off-the-run Treasury securities can enhance market liquidity. In this paper, I present a direct test of this mechanism and quantify the liquidity support effects at both the individual security level and the aggregate balance sheet level of primary dealers. I utilize operational considerations related to the Treasury's selection of buyback securities that are independentof the securities’ liquidity conditions—notably, whether a security matures in a month characterized by significant cash inflows to the Treasury—to construct an instrumental variable for the Treasury’s buyback selection decisions. I find that buybacks moderately narrow bid-ask and off-the-run spreads and raise prices for securities listed by buyback, further boost prices for those purchased, and reduce primary dealers’ net holdings of Treasury bills and coupons. The liquidity support effects are particularly pronounced when dealers hold large Treasury inventories. I rationalize these findings using a model in which buybacks serve as predictable demand for dealers facing inventory constraints and holding costs, thereby mitigating illiquidity risks.