2023-10-25 15:30:10
U.S. Treasuries are facing their biggest sell-off in 40 years, with the market turning its focus to its biggest domestic buyer, the Federal Reserve.
Since last year, the Fed has been reducing its holdings of U.S. Treasury bonds and mortgage-backed securities (MBS) at a rate of about $75 billion per month. It has already reduced its holdings of U.S. Treasuries and mortgage-backed securities (MBS) by $1.35 trillion, and is extremely determined to say that the reduction may continue until next year.
While the U.S. Federal Reserve (Fed) continues quantitative tightening (QT), the U.S. Treasury Department is still issuing large-scale debt, which will expose U.S. debt to liquidity risks. Therefore, some believe that the Fed may eventually be forced to do so sooner than expected. Stop its QT project.
This week, the “anchor of global asset pricing” 10-year U.S. Treasury yieldIt once rose above the important level of 5%. After stabilizing slightly on Tuesday, it rose again on Wednesday. At the time of writing,10-year U.S. Treasury yieldClimbing to 4.9%, the 30-year U.S. Treasury yield is above the key 5% level.
Jack McIntyre, investment manager at Brandywine Global Investment Management, said of the Fed and its QT actions: “The Fed may end QT soon if the ‘bond vigilantes’ (bond vigilantes) continue to send strong signals. “
Bond vigilantes are investors in the bond market who sell bonds and raise yields to protest monetary or fiscal policies that they fear will lead to inflation.
When will QT end?
But it seems that the Fed does not believe that QT should be ended earlier than expected. Chairman Jerome Powell said in the US Congress earlier this year that he was “very clear” about the need to continue to reduce the Fed’s balance sheet rather than continue to reduce the Fed’s balance sheet any time after each easing cycle. by its expansion.
He said at the time: “The costs of the Fed’s past quantitative easing policies are now clear. It is now paying high interest rates on the bank reserves created by quantitative easing, which has left a gap of approximately $100 billion in Treasury revenue. “
According to estimates by William Dudley, former president of the Federal Reserve Bank of New York, reserves in the U.S. banking system currently account for about 12% of gross domestic product (GDP), compared with 7% in September 2019. Therefore, he believes that the Fed has enough room for maneuver without changing the QT path, and QT should continue to proceed “automatically.”
As for when QT will end. Dudley pointed out that, assuming an annual asset reduction rate of $900 billion, nominal GDP growth of 4%, and reverse repurchase balances falling to zero, reserves should reach the initial target of 10% of GDP in about two years. At that time, the Fed will slow QT while it evaluates the appropriate composition of the reserve buffer.
Quantitative tightening is not good news for bond markets
But the Fed’s continued quantitative tightening is not good news for the huge U.S. bond market. After the adjustment of the U.S. debt ceiling and the new budget bill in early June this year, the scale of U.S. debt experienced an epic explosion. After exceeding 32 trillion US dollars in 8 months, it took only 3 months to reach a new high of 33 trillion US dollars.
There are signs that buyers of U.S. Treasuries are increasingly wary of holding ever-expanding holdings of longer-dated bonds. Auctions for the 10-year and 30-year Treasury notes were weak this month. As the fiscal deficit continues to expand (in the last fiscal year as of the end of September, the fiscal deficit expanded to US$1.7 trillion), the supply of US debt is expected to continue to increase.
At the same time, demand from overseas buyers of U.S. debt has also been weak, with Japan, the U.S.’s largest foreign creditor, cutting its holdings of U.S. debt to the lowest level since 2019 earlier this year.
Alan Ruskin, chief international strategist at Deutsche Bank, said that the rise in long-term U.S. bond yields means that QT “may be problematic” because it may also force “banks to engage in more risk aversion and lenders face more unrealized losses.” ”, which may form a vicious cycle.
Will the balance sheet reduction plan be forced to halt?
For now, Fed officials are comforted that liquidity is being drawn primarily from its reverse repurchase program rather than from bank reserves, but the risk of falling bank reserves is both theoretically and factually real. Yes, the Fed may eventually be forced to halt its QT program.
Economists at the Federal Reserve Bank of St. Louis said in a September research note: “As QT continues, bank reserves will continue to be the main part of the Fed’s balance sheet reduction. But ultimately, as the reverse repurchase facility “The Fed’s balance sheet shrinkage will put downward pressure on bank reserves.”
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