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Investing.com — U.S. stock markets headed lower for a second straight day on Friday, reversing overnight gains after the Federal Reserve said it would close a potentially significant loophole in banking regulation.
The Fed said that from March 31, banks will again have to count their Treasury bond and cash holdings towards their Supplementary Leverage Ratio. It had exempted such holdings in the first wave of the pandemic to allow the financial system to absorb a massive injection of liquidity as it slashed interest rates and started buying bonds in huge volume.
By 9:45 AM ET (1345 GMT), the Dow Jones Industrial Average was down 267 points, or 0.8%, at 32,595 points. The S&P 500 was down 0.6% while the Nasdaq Composite was outperforming with a drop of only 0.2%.
Some – but not all – analysts have argued that the ending of this exemption will reduce banks’ willingness to hold Treasuries in a year when federal government borrowing is set to skyrocket. If that thesis is proved, it would put significant upward pressure on bond yields, which are already rising amid fears of a return of inflation.
The yield on the 10-year Treasury note rose to an intraday high of 1.74% in response to the news.
However, the Fed indicated that it would take action to mitigate any mechanistic pass-through into yields that could choke off an economic recovery.
“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 central bank said in its statement.
Bank stocks were among those hardest hit by the news. JPMorgan (NYSE:JPM) stock fell 3.0%, while Bank of America (NYSE:BAC) stock rose 2.7%. Higher effective capital requirements would mean, at least on paper, that banks won’t have as much money for share buybacks and dividends.
