Is the Treasury Department/Federal Reserve concerned that the yield curve could become “unglued?” In recent Congressional Testimony from Treasury Secretary Scott Bessent, Bessent stated it is “top priority” that Federal Reserve/Treasury does not lose control of the yield curve, a yield curve that has been perhaps artificially suppressed by Central Bank policies over the past several years.
There was considerable dialogue about Central Bank intervention and its ramifications.
If the Federal Reserve lowers interest rates in response to the possible economic slowdown, the result of the tariffs, tariffs which almost all believe are inflationary, the long end of the Treasury market could stage a dramatic selloff. It is the perfect recipe…the lowering of rates in an inflationary environment all amplified by insatiable demand for funds by the Federal government.
Recent surveys suggest inflationary expectations are at levels not experienced in 30 to 40 years and these expectations are a large component of corresponding bond yields.
It is no big secret that the Treasury market has faced great challenges in recent years. A huge fiscal deficit, stubborn inflation and the weaponization of the dollars are potentially deterring buyers unless longer term yields move higher to accommodate the perceived heightening risks.
There was a considerable discussion at the Congressional Hearing as to who may buy the Treasury debt given the ongoing prolific spending, the massive amount of debt maturing in the next 12 months (about $9 trillion), the violation of accepted limits of maturity brackets [recommended that only 17%-18% of debt matures in 12 months or less…currently around 23%], the decline of foreign ownership of Treasury from 34% in 2014 to 23% today, and the end of QE where the Federal Reserve bought over 50% of issuing debt in prior years.
The Treasury Secretary is attempting to convince Congress to change the amount of Treasuries banks can own by increasing the “Supplementary Liquidity Ratio,” (SLR) meaning banks would be penalized less for holding them.
Banks are increasing their holdings, but the data suggest the amount is paltry in relationship to amount of debt outstanding and government demand for potential buyers.
Banks hold about 6% of their financial assets in Treasuries. The amount was a lot higher in the 1950s and 1960s before the era of credit loosening. It could be safely assumed banks will not hold anything like 50% to 60% proportion of Treasuries as they did back then.
Currently the SLR is around 6%. The Treasury states that even if banks took their Treasury holdings back to 10% if the SLR is tweaked, it would only represent about $1 trillion of additional US Treasury demand. The Treasury states that this is barely a sixth of the increase in Treasuries outstanding over the last three years and only half of what the Federal Reserve has divested from its balance sheet during that period.
Can a potential conclusion be drawn that the Treasury/Federal Reserve is trying to increase the potential pool of Treasury buyers via changing regulations/limitations that were codified in the Dodd Frank legislation that was passed by Congress because of the Great Financial Crisis 17 years ago to help compensate for the large amount of Treasuries that is coming to market? Changing the SLR may also increase much needed liquidity.
In so many dimensions, today is unprecedented. Is the Treasury Department concerned the yield curve will spike by the same record proportions the yield curve became inverted in 2022 and 2023, the result of the most aggressive Federal Reserve in history?
Inflation was/is not transitory and the Central Bank’s outlook and announced/intended policy over the past five years has been almost entirely wrong.
The outcome of yesterday’s 30-year Treasury auction was regarded as “weak,” despite the selloff heading into the auction. Earlier in the day it was thought that the auction would “go off without a hitch” as yields had risen and the outcome of the 10-year auction held two days earlier.
This is the second consecutive auction that produced a similar outcome, an “ominous sign” given the massive demand for funds one primary dealer stated.
Treasuries across the curve sold off. The shorter end because of the outcome of the FOMC meeting [note: Futures are still suggesting three interest rate cuts for 2025] and the longer end because of the “weak” 30-year Treasury auction.
It must be remembered the Federal Reserve sets short-term interest rates and the markets set long term rates.
Equites however staged a handsome rebound on the potential tariff agreement with England and optimism about upcoming talks with China.
Last night the foreign markets were up. London was up 0.31%, Paris up 0.57% and Frankfurt up 0.52%. China was down 0.30%, Japan up 1.56% and Hang Seng up 0.40%.
Futures are flat ahead pivotal trade talks. The 10-year is up 1/32 to yield 4.38%.
