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Crash Up

Published on December 4, 2023 by Premium

The coming months are looking to be very positive for equity markets as rate cuts are expected to occur in the context of significant deficit spending. In the modern financial system, Treasuries are money like assets so deficit spending is comparable to a form of money printing. As interest rates decline, Treasuries become less attractive and investors tend to rebalance into riskier assets. Given the size of the fiscal deficit, investor portfolios are growing significantly

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Inventory Costs

Published on November 27, 2023 by Premium

Treasury yields may resume their upward trend as the repricing of Fed policy expectations is likely over and swap spreads continue to widen from on-going issuance. Treasury yields can be thought of as determined by the market's expectation of the path of Fed policy and an extra "premium" to entice investors. Steady progress towards disinflation has recently led a downward repricing in rates as the market both moved up its expectation of Fed rate cuts

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Regs Will Increase Until Liquidity Improves

Published on November 20, 2023 by Premium

The Fed's recent Treasury market conference offered three notable insights that suggest Treasury market liquidity will continue its structural decline. First, dealer balance sheet constraints have moved from ones that could be solved through central clearing to those that would require other adjustments. Secondly, mandatory Treasury repo clearing may reduce market liquidity by raising the cost of financing due to higher collateral haircuts. Lastly, mutual funds may not become significant marginal investors in cash Treasuries

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RIP Federal Funds Market, 1928-2023

Published on November 13, 2023 by Premium

The Federal Funds market has been in an undead state for over a decade, but may now finally wither away and allow SOFR to become the official policy rate. Almost all lending in the funds market is from Federal Home Loan Banks, who are ineligible for interest on reserves and lend in the funds market to earn a return on their cash. Potential new regulations are likely to significantly shrink the fed funds market by

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Just One More

Published on November 6, 2023 by Premium

The Quarterly Refunding Anouncement sparked a sizable decline in Treasury yields, but the rally may not last. The announcement was well received because it guided towards just one more increase in coupon sizes, a compositional skew towards medium term tenors, and a potential for further increases in the share of bills. These developments were positive relative to expectations, but the situation remains dire. The bond bear market may resume shortly as historically high levels of

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Neutralizing QT

Published on October 30, 2023 by Premium

The rapid decline in the Fed's RRP facility has not impacted financial conditions, but will eventually provide a modest degree of easing in the coming months. RRP balances have declined by almost $1.1t since June largely due to significant bill issuance, which financed a $800b increase in the Treasury General Account. The balance of the decline went into commercial banks and vanished through QT. With net bill issuance set to increase, the RRP may approach

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One Weird Trick

Published on October 23, 2023 by Premium

The Treasury appears to plan on further increasing the share of bill issuance to support the Treasury market. While Congress determines the size of the fiscal deficit, Treasury determines the composition of debt issuance. This discretion allows Treasury to influence financial conditions by adjusting the supply of duration. The most recent Treasury refunding agenda commissioned a study on an additional benchmark bill and the market's capacity for bill absorption, which suggests a further move towards

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Half Anchored

Published on October 16, 2023 by Premium

Median longer term inflation expectations have been returning towards 2%, but the median hides significant dispersion that has widened and persisted. A range of surveys finds that a notable fraction of survey respondents since 2021 have revised their expectations away from 2%. At least a third of households now appear to have durably revised their inflation expectations to above 4% in the coming years. Surveys of business inflation expectations also show an upward shift but

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Fool Me Once

Published on October 9, 2023 by Premium

The market may finally be overestimating the expected path of policy after two years of persistently underestimating the Fed's willingness to hike. Recent data suggests that economic growth and employment continue to steadily increase even as inflation is clearly trending lower. This suggests a softening labor market is not necessary to lower inflation and raises the bar for additional tightening. At the same time, financial conditions are notably tightening with the steady rise in longer

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Slow Money

Published on October 2, 2023 by Premium

Real money investors are unlikely to be the next marginal buyer of Treasuries as they have historically preferred other assets and are subject to certain constraints. Real money investors like pension funds and life insurers manage vast pools of assets and look for longer dated assets to match their longer dated liabilities. They appear to be natural buyers of Treasuries, but have in practice had little exposure even before the QE era. They may change

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