While the Treasury market has grown in size, it has become dysfunctional as regular buyers have withdrawn from the market. To ease this, the US Fed will step in to support the market later this year.
Credit Suisse Group’s Zoltan Pojar made that observation in a note to clients on Wednesday, predicting the Fed would resume asset purchases this summer.
Pojar’s analysis shows that relative-value trading funds won’t buy Treasuries unless they are significantly lower than overnight index swaps (OIS). Banks, too, are likely to turn to the funding market instead of buying Treasuries as cash is scarce. Currency-hedged buyers of U.S. Treasurys were “out of reach” by rising costs, and geopolitical events have dampened the appetite of big money managers for U.S. Treasuries.
Weaker demand from fugitive buyers will dampen demand for Treasury auctions, triggering a selloff in equities, credit and emerging markets, Pojar said.
“It’s a dead end,” Pojar said. “There’s no change of course by the US authorities and terminal rates may need to go even higher. None of this is good for risk assets or Treasuries.” continued.
As a result, the U.S. authorities will end the balance sheet reduction that began last June and resume buying Treasuries to support the market, Pojar said.
However, “it should not be expected to boost risk assets. Unlike quantitative easing (QE), which was done in the context of low interest rates and support for risk assets, the next QE will be in the context of a dysfunctional Treasury market. The aim is to keep swap spreads orderly at high interest rates, not to keep yields low and push up the price of risky assets.”
news-rsf-original-reference paywall">Original title:Fed Will Restart QE to Stabilize Treasury Market, Pozsar Says(excerpt)