It appears that the stakeholders in the US money system have increasingly diverging priorities. There we heard Jay Powell in his two testimonies to Congress on Tuesday and Wednesday that the fear of inflation going around is baseless, at least for now. Obviously, he has his eye on the long end of the Treasury market as the key reference rate for corporate financings. After all, the sell-off has driven 10-year yields from 50bp to 1.52% overnight in the space of only 6 months.
That’s quite a move, and the Fed chair is desperate to set the record straight and prevent that long end from blowing out even further. As I said in another
post this week, to get this year’s recovery right isn’t a no-brainer but rather a walk on eggshells. The market may anticipate a growth bonanza that may not materialise to such an extent. And if long yields overdo it on their way up, there may not be a recovery to speak of or at least none that is so necessary to bring America’s economy back.
Then, there is Mister Market. The investor community is evidently rattled. Short-sellers are at work, and the pundits who after years of getting Treasuries wrong smell blood and lighten things up with their sometimes racy commentaries. The recent acceleration of yields on the up constitutes a panic mode. I think it’s fair to assume that the technically-minded traders consider the yield high of nearly 2% early last year in plain sight. And I guess we have seen in overnight stock markets what tech investors prefer.
And then, there is the US Treasury itself. Janet Yellen didn’t do the market any favours when she dropped a hands-off remark about long-term issuance to make sense earlier in the week. In the absence of foreign buyers, and a still persistent reluctance of the Fed to step in and control the yield curve, the Treasury secretary has the invidious task of funding a federal deficit that moves between 15-20% of GDP. So, was it a lapse on her part to announce massive supply, or what was she doing?
Well, call me crazy as the Treasury must be calculating the immense interest cost of debt day-in-day-out, but if you think about it, it may actually make sense for Yellen to talk long yields up to a certain extent. In the case of the domestic bid to wince at the sharp drop in bond prices, the foreign bid to become absent amid concerns of a dollar crisis, and the Fed trying to make sure it doesn’t have to print another gazillion to arrest the rate move, who is she going to call to buy her bonds?
Exactly, the banks. But the banks playing the yield curve have their own targets. Throughout 2018 and 2019, particularly when the curve dipped into negative territory at one point, it made no sense for them to engage. Now that the 2/10-year differential has reached 135bp and is a smidge away from the 2016 high, and the 3-month/10-year differential is also back to a 4-year high of around 130bp, there is a much larger incentive for banks to load up and make money on the carry.
Yellen must have sounded every bank CEO in the land to figure out their sweet spots, and it can be assumed that at the right price they are all going to play ball and bail the Treasury out. To be sure, the government bond holdings of US commercial banks have already accelerated during the health crisis and stand at a total of almost 4 trillion dollars, but as I titled a recent
post, “Aren’t we all policy banks now”? So, Yellen might, or rather must get her way and her pound of flesh after all.
But then, we have the consumers and the citizenry at large as another set of stakeholders. A material rise in long yields isn’t what anyone wants there. The housing market depends on mortgage rates, and they are naturally coming under upward pressure parallel with Treasury yields. Prospective homebuyers must be keeping a jealous watch over the market moves. At the same time, the unemployed and low-income workers want to make sure they receive Yellen’s monthly cheque.
And what about the economy? Bank balance sheets aren’t infinite, and if Yellen siphons off most of their liquidity to fund her stimulus cheques and other public programs, what will be left for private enterprise? Small businesses are one of the most important stakeholders of the system, but they may well fall through the cracks. Of course, Big Government will support and subsidise lending to them. However, what does that say about the future of capitalism?
In other words, it is all over the place and blatantly obvious that the key stakeholders in America aren’t aligned. They have their own priorities to look after it seems, and they are pulling in diverging directions. Let’s just hope neither of them is given the room to overdo it with their specific agendas and bring the house down.
