Making markets in US Treasuries, and other bonds as well, is no longer a profitable business. The Federal Reserve has purchased so many of the securities that “two-way flow” has all but dried up. Broker dealers make their money out of flow, buying low from one seller and selling high to another buyer. While bad news for the broking community, this is good for the average investor.
It is well-known that transactions costs must be recouped in order to justify an investment. The expected return on any transaction is composed of 2 parts: the return for taking risks and the return as compensation for transactions costs. One unexpected benefit from the Federal Reserve’s bond buying spree has been to drive down transactions costs in the bond markets. Over-the-counter bond market trading used to be a cushy business, dominated by primary dealers who were mandated and protected by the Central Bank. However, once the Federal Reserve became a major player it has demanded cheaper spreads and electronic trading platforms with lower transactions costs. In 2013, electronic trading accounted for 49% of US Treasury transactions versus 31% the year before.
While the big banks shed labour from dealing desks in favour of computers, the big beneficiaries are investors who no longer have to pay inflated transactions costs that required compensation. This benefit is ultimately reflected in permanently lower interest rates across the yield curves.