Plumbing Notes: A Faulty Relief Valve
why the Fed's SLR rework won't be the major booster of UST demand
Welcome to Plumbing Notes #6. Major (pending) works: an infographic deck on the modern Eurodollar system [███▒%], a detailed look at the Fed’s Great Rebalancing [█▒▒▒%], and a new central bank target rate [███▒%]. But first, a Plumbing Notes on why the imminent easing of the Fed’s SLR (explained in the video below) is unlikely to be a significant driver of bank UST (U.S. Treasury) demand...
Money Market Commentary: A Faulty Relief Valve
The suppression of short-end volatility continues, with the U.S. central bank set to announce at least one type of routine UST (U.S. Treasury) bill operations. Fed officials are set to unveil their first MBS reinvestment schedule (into bills) on December 11th. Bill purchases designed to preserve interbank liquidity, a.k.a RMOs (reserve management operations), should arrive a month or so later, perhaps following more imminent “ceiling management operations” (CMOs): an extra add-on of reserve injections that enables the Fed to hold money market rates well within its target band1.
Market participants believe in the Fed & Treasury’s efforts to calm the short end, much like interventions across the rest of the curve. Treasury buybacks, deferred increases in duration (i.e. note and bond) issuance, and the U.S. Empire continuing to avoid fiscal dominance have placed a cap on yields. Yet, their latest incoming alchemy, the rework of a key regulatory ratio that banks can adopt as early as Q1 2026, may not deliver the “juice” leaders envision. The Fed’s Relief Valve, a reduction of its SLR (supplementary leverage ratio) — a ratio that requires banks to hold extra capital whenever they expand their balance sheets — will only be partially opened.
As expected, despite calls for greater balance sheet relief for the largest market makers in U.S. sovereign debt, the U.S. regulatory complex has opted to implement the least influential change to the SLR, choosing to deliver only tiny incentives for banks to acquire and absorb more USTs.
The most prominent dealer banks will soon “benefit” from needing to maintain a lower enhanced supplementary leverage ratio (eSLR), an extra “buffer” on top of the standard 3% SLR requirement, resulting in a looser leverage ratio. The new eSLR will decline from a fixed buffer to half of a bank’s G-SIB surcharge2, a separate amount of capital that G-SIBs (global systemically important banks) must hold to offset their global risk “footprint”. The higher the “bucket”3 a bank belongs to, the more capital required.
Banks’ overall SLRs4 and their capital requirements will ultimately decrease. The suspense, however, lies in whether banks will, in response, abide by conventional wisdom and provide a steadier bid for America’s sovereign debt.
If so, this will align with monetary leaders’ latest goal. The U.S. regulatory complex has revealed that, with the latest SLR “easing”, their primary objective involves enticing the largest banks to participate more in “high-volume, low-margin” trades — Fedspeak for wanting financial giants to absorb and intermediate more (i.e make a larger share of markets in) U.S. Treasuries. In Conks’ view, however, other catalysts will be the major boosters of bank demand, such as banks’ growing deposit bases, which will fund more security purchases as the economy grows. A less-hostile-than-expected Basel III endgame will also free up capital that banks can deploy into USTs.
As for the eSLR, neither dealers nor commercial bank subsidiaries of the largest financial giants should suddenly absorb meaningful amounts of U.S. government debt. The (supposed) foremost benefit of lowering leverage ratios will be to reduce the odds that the SLR becomes the “binding constraint” i.e. requiring more capital to satisfy leverage compared to risk-based standards (i.e. RWAs a.k.a risk-weighted assets) during crises5, allegedly preventing6 market makers from absorbing USTs. Banks must hold capital to fulfill an expansive range of risk-based capital requirements (RWAs) and leverage-based requirements (such as the SLR), but they only need to maintain capital equal to the highest of the two categories, not both combined.
For instance, if a bank’s assets require $100 in capital to satisfy RWAs and $60 to meet the SLR, it must hold only $100, not $160. The coming SLR “ease” will ensure that risk-weighted assets become the binding constraint for all large banks.
Freeing up leverage capital to keep banks bound by risk-based capital won’t necessarily entice banks to buy USTs. Merely lowering the amount of required leverage capital, say from $60 to $50 in the above example, does not alter the fact that a bank is bound by $100 in risk-based requirements. It provides no relief for banks seeking to be heavily weighted toward risky exposures that likely boost profitability within a restrictive regulatory regime. Technically, banks do have more excess leverage capacity to buy 0% risk-weighted assets, which don’t increase risk-based requirements and thus demand capital. Even so, from concerns over duration (i.e. interest rate) risk to a plethora of other internal decisions, various motives explain why a bank has chosen not to use up that $40 in seemingly “excess” capacity. A bank’s dealer subsidiary may therefore have little incentive to warehouse more UST inventory, and it’s a similar outcome at a banking giant’s commercial bank arm. While optimizing for risk-based capital, bank treasurers will likely acquire few USTs (solely because of a reduced SLR), as they would fund those purchases with reserves, which are also 0% risk-weighted and hoarded to meet an ocean of liquidity requirements. A large bid from the largest banking giants is thus not assured.
The good news is that, regardless of the SLR, Conks’ major plumbing gauge — the swap spread curve — has revealed officials are #winning their battle against duration. The major forces that pushed swap spreads into highly negative territory — signaling greater plumbing frictions — have died down. Deficit fears have dwindled, while Treasury buybacks only grow from here. Increases in UST coupon issuance sizes remain on pause, the Fed’s QT has concluded, and rumors have emerged of a switch to a secured Fed target rate. Swap spreads have widened (rallied) significantly, fueled by intense optimism around both SLR & non-SLR (“non-relief valve”) catalysts. This widening should slow down until regulators realize — as usual, after implementation — that more juice will be required in the form of easier regulations, prompting the next round of deregulatory hype.
Despite the Fed’s lackluster relief valve, set to be adopted by banks as soon as Q1 next year, forward-looking plumbing gauges have continued to price in a scenario in which the Fed capitulates and starts enforcing some of Conks’ proposed relief valves, but likely not a true greasing of the UST plumbing: excluding USTs from risk-based capital ratios. An SLR change that only reduces the odds that leverage capital will become the binding constraint in volatile times will satisfy some but not all key regulatory officials. Another push from the Fed’s rising deregulatory arm may prompt the deployment of a (stronger) relief valve sooner rather than later.
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More Plumbing Notes
From the Conks feed (chat): how to monitor the Fed’s expected reserve injections (RMOs), a SOFR-FF basis primer, and more…
In today’s Pro, a graphical overview of eSLR changes, swap spreads catalysts + outlook, and more color…
Chartbook (December 8th, 2025)
Changelog: N/A
WIP: STIR monitor/Treasury monitor to accompany these updates
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for insured depository institutions (IDIs), e.g. the commercial bank subsidiaries, inside a bank holding company, they will be subject to 50% of their bank holding company’s surcharge, capped at 1%
with 1% being the least (required by Bucket 0 banks) and 4.5% being the largest risk-based capital BUFFER required for the G-SIB surcharge (assigned only to JPMorgan as of publication, the sole member of “Bucket 4”)
Conks will refer to the eSLR as the SLR for simplicity here on out…
periods when SLRs tend to grow binding for most banks
Agree completely on eslr impact. Has the FOMC or NYFRB indicated something that justifies 20BN of Bills buying above MBS and 20BN for 5 months of oops we drained reserves too fast and need to reload by 100BN?