How SLR Reforms Are Reinventing Treasury Market Stability and Opening Fixed-Income Opportunities

The U.S. Treasury market, the world's deepest and most liquid fixed-income arena, has faced growing fragility in recent years. Yet a subtle regulatory shift—the reform of the Supplementary Leverage Ratio (SLR)—is now poised to reshape this landscape. By easing constraints on banks' balance sheets, these changes could bolster market resilience, reduce Treasury yields, and unlock opportunities for fixed-income investors. Here's why.

The SLR's Hidden Hand in Market Liquidity

The SLR, a post-2008 capital buffer requiring banks to hold 3% (or 5% for G-SIBs) of Tier 1 capital relative to total assets, was designed as a “backstop” to risk-based capital rules. But its unintended consequence became clear: Treasuries, the safest of assets, were penalized. Banks, constrained by SLR limits, reduced Treasury holdings to avoid breaching capital requirements. This undermined their role as market makers—the critical intermediaries who stabilize the $33 trillion Treasury market by absorbing volatility.

The 2020 pandemic exposed this flaw. When the Federal Reserve temporarily exempted Treasuries and reserves from SLR calculations, banks' effective SLR ratios rose by over 1 percentage point, freeing $3.4 billion weekly in Treasury holdings for constrained institutions. The Merrill Lynch Option Volatility Estimate (MOVE) index, a measure of Treasury market liquidity, dropped sharply (see below), proving the SLR's binding effect on dealer activity.

The 2025 Reforms: Permanent Relief or Regulatory Tightrope?

The Federal Reserve's 2023–2025 reforms aim to make this temporary fix permanent. By permanently excluding Treasuries and reserves from SLR calculations, policymakers seek to:
1. Boost Treasury market liquidity: Dealers can hold more Treasuries without capital penalties, reducing “dash-for-cash” risks during crises.
2. Lower Treasury yields: Treasury Secretary Scott Bessent estimates reforms could reduce 10-year Treasury yields by 30–70 basis points, benefiting borrowers and investors alike.
3. Rebalance bank portfolios: Freed from SLR constraints, banks may expand into mortgage-backed securities (MBS) and corporate bonds, driving demand for these assets.

The reforms, however, walk a tightrope. Critics like former Fed official Daniel Tarullo warn against weakening post-crisis safety buffers. The key compromise? Exempting only low-risk Treasuries and reserves while retaining stricter rules for riskier assets. The Group of Thirty report endorses this approach, noting that SLR reforms can enhance resilience without sacrificing capital adequacy.

Investment Implications: Fixed Income's New Era

The reforms create a favorable backdrop for fixed-income investors in three ways:

1. Lower Treasury yields, higher prices: As banks' Treasury holdings rise, demand for Treasuries could push yields down further, benefiting holders of long-dated bonds. The 10-year Treasury yield, already at 3.7% (as of June 2025), may dip toward 3.0% if reforms proceed.
2. Stabilized MBS and corporate bonds: Banks' expanded capacity to hold MBS and investment-grade corporates could narrow spreads between these assets and Treasuries. Consider ETFs like TLT (long-term Treasuries) or MBB (mortgage-backed securities).
3. Reduced volatility risk: A more liquid Treasury market means fewer “flash crashes” in fixed-income sectors. The MOVE index's post-reform stability could make duration-sensitive strategies safer.

Risks to Monitor

• Regulatory delays: While the Fed aims to finalize reforms by late 2025, political pushback or unintended consequences (e.g., banks overleveraging riskier assets) could stall progress.
• Global rate trends: If the Fed hikes rates further, Treasury yields could rise despite SLR reforms. Track the Fed Funds Rate and inflation data closely.

Bottom Line: Seize the Treasury Opportunity

The SLR reforms are a regulatory reset that aligns capital rules with real-world market needs. For investors, this means:
- Overweight Treasuries: Use IEF (7–10 year Treasuries) or TIP (TIPS) to capitalize on yield compression.
- Diversify into MBS: ETFs like MBG offer exposure to agency MBS with reduced liquidity risk.
- Stay cautious on high yield: While SLR reforms are a positive, overexposure to junk bonds remains risky without broader credit cycle improvements.

Historically, this approach has been rewarded. When the Federal Reserve announced SLR reforms or exemptions between 2020 and 2025, a buy-and-hold strategy for Treasury ETFs (TLT, IEF, TIP) over six months delivered an average return of 2.15% with a maximum drawdown of just 1.83%, underscoring the strategy's resilience and risk-adjusted performance.

The Treasury market's resilience is no longer a given—but with SLR reforms, it may become a safer bet than ever.