Let’s start the week with our regular Fed watch. In the week to Wednesday, 3 June, the balance sheet grew by 67.9 billion dollars, maybe by a smidge more than in the previous week. At first sight, this is promising news, at least in relative terms. Despite the gargantuan increase of almost 2.9 trillion in only 12 weeks, to a current total of 7.17 trillion, the growth in Fed assets has recently been slowing. Accordingly, the purchases of only US Treasuries has been trimmed from 60 billion to 5 billion per day.
As pointed out last week, this is mostly owed to the Fed’s rotation in asset purchases. As fewer Treasuries are being bought, more firepower is being used to gobble up mortgage, investment grade and high yield bonds to support those asset markets. While this may create the perception of a more balanced approach and has certainly mitigated the fall-out in credit mid-March, it does not belie the fact that there are simply no more markets and everything trades on the bid side of the Fed’s excess liquidity.
But the gradual slow-down in asset purchases as a whole is a good thing, isn’t it? Well, yeah, as long as markets do what they are supposed to do. And there, we have been suspecting for a while that cracks are to open up. Last week, this space has finally been proven right. The rate curve had crashed amid the unwind of gazillions of hedge fund positions, mostly long risk and short government bonds. Then, the tsunami of Treasury short-covering pushed the 10-year yield to an unbelievable 31bp.
After about 2 weeks of unprecedented bond volatility in March, long yields moved virtually side-ways for the entire April and May, in the narrow range of 60-75bp in the 10-year, and 115-145bp in the 30-year. The long end and the shape of the curve as such were basically engineered by the Fed, something we have only been used to from the Bank of Japan, crazy as they are in a monetary sense. The trillions of newly minted money have apparently been put to some use.
What more of an invitation did the corporate sector need to get much sought after financing done in the capital markets? And what a burden that lifted off the banks that were facing treasurers twitching to draw on committed credit lines in the multiple billions. Some were right there to use the window and sell bonds at digestible spreads over those ultra-low reference yields. Think of Amazon, for example, being quick on their feet and raising 6.5 billion in cheap debt in 10-, 30- and 40-year maturities on Monday last week.
Not a minute too early, mind you! The rate market has since moved and the long end of yields visibly broken up from the previous range. The unexpectedly good labour numbers on Friday gave them a final jolt. 10-year rates rose by 25bp to 0.89% and 30-year by 27bp to 1.67%. Momentum is strong now and, just technically, should move those yields back up to levels closer to 1.50% and 2%, respectively.
The improving macro picture as well as de-emphasising the Fed’s focus on US Treasuries has evidently taken its toll. The market is telling us that the Fed’s attention and ongoing purchases have been and will be a prerequisite for low yields going forward. The better labour numbers are by no means a green light for monetary policy to be taking it easy from here. A rising rate curve is the last thing the economy needs while it is struggling to get on its feet again.
It rather means that Jay Powell & Co cannot afford to take the foot off the gas pedal. If yields continue to go up as predicted, we will very likely see a rotation back into Treasuries and possibly a spike in the overall weekly purchase volumes again. Not that Steven Mnuchin doesn’t rely on every piece of demand out there. We have to remind ourselves that he sold 900 billion in new Treasury bonds in April alone. This is almost as much as China’s total holdings, which should give us a perspective of things.
On the back of all this, America’s national debt is creeping ever higher. By last Wednesday’s count, it stood at 25.83 trillion dollars, 380 billion more than in the previous week. My new prediction is that we will see a break of the 30 trillion threshold before a president gets inaugurated again next January. Breathtaking…!
