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Passing the Buck

Published on January 29, 2024 by Premium

The Treasury has an opportunity to lobby the Fed for an earlier QT taper by both rapidly draining the RRP and pushing up repo rates through further increases in net bill issuance. While Congress determines the size of the fiscal deficit, the Treasury and Fed together determine the supply of duration to private investors. The Fed has increased the overall level of issuance to private investors through quantitative tightening, but Treasury has cushioned the market

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Token Resistance

Published on January 22, 2024 by Premium

Fed officials are unlikely to meaningfully push back against the market's aggressive pricing of rate cuts regardless of the rise of risk assets. Real rates remain at cycle highs from declining inflation expectations even as recent inflation data is very close to 2%. Fed officials perceive financial conditions to be restrictive even with six rate cuts priced in the market, and are also concerned with potentially overtightening. The high degree of uncertainty and the Fed's

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The QT Debates

Published on January 16, 2024 by Premium

Fed officials are planning to taper QT, but have expressed a range of views that place a taper anywhere from this quarter to much later. In the absence of a rise unemployment, the path of QT will be guided by the amount of liquidity in the financial system. However, Fed officials have expressed disagreement on which components of liquidity to emphasize. They have focused on RRP levels, reserve levels, or the consolidated level of the

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Doves Ascendent

Published on January 8, 2024 by Premium

Monetary policy going forward will be increasingly biased towards rate cuts as both inflation has declined and employment growth appears to be slowing. Policymakers set policy with an eye towards a trade-off between employment and inflation, with the balancing of risks dependent upon the policymaker's values. The record of the current Fed leadership and political donations of Fed staff indicate a left leaning preference, suggesting an emphasis on employment over inflation. While the Fed is

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Transitory Disinflation

Published on January 2, 2024 by Premium

Inflation declined rapidly largely due to onetime supply side improvements and will likely resurface as easing financial conditions rekindle demand. Improving supply chains and increases in labor force participation played a major role in moderating inflation by increasing the overall supply of goods and services. The Fed's restrictive policy also played a role by having some impact in dampening overall demand, but that policy in the process of being unwound. Household purchasing power remains very

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Independent Tracks

Published on December 18, 2023 by Premium

Chair Powell's intention to separate interest rate and balance sheet policy will likely extend quantitative tightening to well into 2025. The Fed has historically linked their interest rate and balance sheet policy together so that the two have always moved in the same direction. But Chair Powell appears to endorse the view that QT can continue when rate cuts are intended to normalize interest rates rather than to add accommodation. With current policy perceived to

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Reflexivity

Published on December 11, 2023 by Premium

A sharp decline in interest rates in benign economic conditions opens up the possibility of a re-acceleration in economic activity that would limit the number of future Fed cuts. One mechanism through which higher interest rates slow the economy is through reduced lending, where higher rates discourage borrowers and prompt lenders to retrench on credit concerns. Despite an aggressive rise in rates, a wide range of measures on credit quality show only modest deterioration to

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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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