Breaking The Bond Market – The Crisis Is Real!

Bond Markets Are Suffering from Rising Volatility and Price Moves, as Central Banks lift rates and threaten Quantitative Tightening to try to tame raging inflation. And the word “crisis” is not hyperbole. Liquidity is quickly evaporating. Volatility is soaring. Once unthinkable, even demand at the government’s debt auctions is becoming a concern. Conditions are so worrisome that Treasury Secretary Janet Yellen took the unusual step last Wednesday of expressing concern about a potential breakdown in trading, saying after a speech in Washington that her department is “worried about a loss of adequate liquidity” in the $23.7 trillion market for US government securities.

Today breaking the bond market the crisis is real and again it’s martin north from digital finance analytics on the disposed covering finals and problems with a distinctively australian flavor well bond markets are suffering from rising volatility and price moves as central banks lift rates and threaten quantity of tightening to try to tame raging inflation and the

Word crisis is not hyperbole liquidity is quickly evaporating and volatility is soaring once unthinkable even demand at the u.s government’s debt auctions is becoming a concern indeed conditions are so worrisome that u.s treasury secretary janet yellen took the unusual step last wednesday of expressing concern about a potential breakdown in trading saying after

A speech in washington that a department is worried about a loss of adequate liquidity in the 23.7 trillion dollar market for u.s government securities i made my mistake if the treasury market seizes up the global economy and financial system will have much bigger problems than just elevated inflation the us treasurer’s market swell from five trillion dollars in

2007 to 17 trillion in early 2020 to now nearly 24 trillion while banks are facing more regency constraints that they say make it more difficult to intermediate trades the federal reserve for example which has lifted the target cash rate by 300 basis points this year is now also reducing the size of its balance sheet by letting its bonds reach maturity without

Buying more a move which investors fear could exacerbate price swings and so now the treasury is posing the questions as part of its regular survey of dealers before its quarterly refunding announcements and they’re asking primary dealers of u.s treasuries whether the government should buy back some of its bonds to improve liquidity in the 24 trillion dollar market

Treasurer’s asking dealers also about the specifics of how buybacks could work in order to better assess the merits and limitations of implementing a buyback program these include how much it would need to buy in so-called off the run treasuries which are older and less liquid issues in order to meaningfully improve liquid in those securities our treasury is also

Querying whether reduced volatility in the issuance of treasury bills as a result of buybacks made for cash and maturity management purposes could be a meaningful benefit for treasury or investors plus it’s also asking about the costs and benefits of funding repurchases of older debt with increased issuance of so-called on the run securities which are the most

Liquid and current issue the treasury is acknowledging the decline in liquidity and they’re hearing what the street has been saying said calvin norris portfolio manager and u.s right strategy agent asset management i think they’re investigating whether some of these measures could help to improve the situation and he said buying back off the run treasuries could

Potentially increase liquidity of outstanding issues and buyback mechanisms could help contain price swings for treasury bills which are short-term securities however when it comes to longer days your government bonds investors have noted that a major constraint for liquidity is a result of a rule introduced by the federal reserve following the 2008 financial crisis

That requires dealers to hold capital against treasurers limiting their ability to take on risk particularly at times of high volatility that lying cause of the lack of liquidity is that banks due to their supplementary leverage ratios being capped don’t have the ability to take on more treasuries and i view that as the most significant issue right now said norris

The fed in april 2020 temporarily extended treasuries and central bank deposits from the supplementary leverage ratio a capital adequacy measure as an excessive bank deposits and treasury bonds raised bank capital requirements on what are viewed as safe assets but it let that exclusion expire and big banks had to resume holding an extra layer of loss absorbing


Capital against treasuries and central bank deposits the treasury borrowing advisory committee that’s a group of banks and investors that advise the government on its funding in the u.s have said that treasury buybacks could enhance market liquidity and dampen swings in treasury bill issuance and cash balances well of course they would say that they’re talking

Their own book and the committee also added that the need to finance buybacks with increased issues of new securities could increase yields and be at odds with the treasurer’s strategy of predictable debt management if the repurchases were two variable in size or timing but the bond market is indeed in turmoil and in fact everywhere you turn the biggest players

Are in retreat from japanese pensions and life insurers to foreign governments and u.s commercial banks where once they were lining up to get their hands on u.s government debt most have now stepped away and then there’s the federal reserve which a few weeks ago ups the pace that it plans to offload treasuries from its balance sheet to 60 billion dollars a month

If one or two of these usually set for our sources of demand were bailing the impact while noticeable would likely be little cause for alarm but for every one of them to pull back is an undeniable source of concern especially coming on the heels of the unprecedented volatility deteriorating liquidity and weak auctions in recent months the app shot is according to

Market watches that even with treasuries tumbling the most since at least the early 1970s this year more pain may be in store until new consistent sources of demand emerge and it’s also bad news for you as taxpayers who will ultimately have to foot the bill for higher borrowing costs we need to find a new marginal buyer of treasuries as central banks and banks

Overall are exiting stage left said glenn capello who spent more than three decades on wall street bond trading desks and is now a managing director at mishler financial it’s still not clear yet who that will be but we know they’re going to be a lot more price sensitive the current yields on treasuries are extended with the 10-year in the u.s sitting at 3.996 a

Rate not seen since 2007 and if you look around the world whether it’s japan or australia or the uk treasury yields are also much higher than normal now to be sure many have predicted treasury market routes over the past decade only for buyers and central banks to swoop in and support the market indeed should the fed pivot away from its hawkish policy tilt as some

Are wagering the brief rally in treasures last week may be just the beginning but analysts and investors say that with the fastest inflation in decades hamstringing the ability of official solution policy in the near term this time is like this in much different the fed unsurprisingly represents the largest loss of demand of the central bank more than doubled its

Debt portfolio in the two years through to 2020 to in excess of eight trillion dollars the sum which includes mortgage-backed securities may fall to 5.9 trillion dollars by mid-2025 if officials stick to that current roll of plans while most would agree that lessening the central bank’s market distorting influences is healthy in the wrong run it nevertheless is a

Start reversal for investors who have grown accustomed to the fed’s upsized presence since the year 2000 there has always been a big central bank on the margin buying a lot of treasuries credit swiss groups sultan pozar said now we’re basically expecting the private sector to step in instead of the public sector in a period where inflation is as uncertain as it has

Ever been we’re asking the private sector to take down all these treasurers that we’re going to push back into the system without a glitch and without a massive premium he said still if it was just the fed with its long telegraph band that sheet runoff reversing course market angst would be much more limited but it’s not because prohibitively steep hedging costs

Have essentially frozen tokyo’s giant pension and life insurance companies out of the treasury market as well and yields on yours 10-year notes have slumped well below zero for japanese buyers who pay to eliminate currency fluctuations from their returns even as nominal rates have jumped above four percent hedging costs have surged in tandem with the dollar which

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Has climbed more than 25 this year versus the yen the most in data compiled back to 1972. as the fed has continued to boost rates to tame inflation excess of eight percent japan in september intervened to support its currency for the first time since 1998 raising speculation the country may need to start selling its horde of treasuries to further prop up the yen

And it’s not just japan countries around the world have been running down their foreign exchange reserves to defend their currencies against the surging dollar in recent months emoji market central banks have trimmed their stockpiles by 300 billion dollars this year according to data from the imf that means limited demand at best from a group of prime insensitive

Investors that’s traditionally put about 60 percent or more of their reserves into us dollar investments people brookvar chief investment officer of bleakly financial groups said on monday it’s dangerous to just assume that the u.s treasury will ultimately find buyers to take the place of the fed foreigners and the banks in fact citigroup flared concerns that

The drop in foreign central bank holdings may set off fresh turmoil including the potential for so-called value at risk shocks when sudden market losses force investors to rapidly liquidate positions investors should bet on the drop-in swap spreads to position for continued central bank selling and for further dash for cash style liquidity events jason williams a

City group strategist wrote in a recent report vis shock type events are more likely given fed risks are still pointed hawkish of reports said and over the past decades when one or two key buyers of treasuries have similarly backed away others have been there to pick up the slack but that’s not what’s occurring this time around according to jp morgan chase demand

From u.s commercial banks has dissipated as federal policy tightening drains reserves out of the financial system in the second quarter banks purchased the least amount of treasurer since the final three months of 2020. the drop in central bank demand has been stunning as deposit growth has slowed sharply this has reduced bank demand for treasuries jp morgan said

Particularly as the duration of their assets have extended sharply this year the u.s treasury title return index has lost about 13 this year almost four times as much as in 2009 and it’s the worst result for the full year on record for the gauge since its 1973 inception yet as the structural support for treasures gives way others have stepped in to pick up the slack

Albeit at higher rates household a capsule group that includes u.s hedge funds saw the biggest jump in second quarter treasury holdings amongst investor types tracked by the fed some see good reason for private investors to find treasure attractive now especially given the risk of fed policies hunting tipping the us into a recession and with yields a multi-decade

Highs the market is still trying to evolve and figure out who these new end buyers are going to be said gregory franello head of u.s rates trading and strategy at emma that securities ultimately i think it’s going to be domestic accounts because interest rates are moving to a point where they’re going to be very attractive john madari a portfolio manager at vanguard

Said large pools of excess savings held at u.s banks earning next to nothing will prompt people to shift into the short end of the treasury market evaluations are good with the fed getting closer to the end of its current hiking cycle he said the question is whether you are willing to take duration risk now or stay in the front end until the fed reaches its policy

Peak but still mostly the backdrop favoring high yields and a more turbulent market a measure of debt market volatility surged in september to the highest level since the global financial crisis while a gauge of market depth recently hit the worst level since the onset of the pandemic the fed another central banks had for years been the ones suppressing volatility

And now they’re actually the ones creating it but rather than slower even stop the pace of rate increases which would only resurrect the notion that there’s indeed a fed put designed to bail out investors the central bank could choose to slow quantitative tightening where is quantitative easing or qe injects liquidity into the financial system through bond purchases

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Qt has the opposite effect instead of selling bonds the fed is allowing the nine trillion dollars or so of years treasuries and mortgage securities it has accumulated on its balance sheet since 2008 to mature without replacing them the amount of qt conducted by the fed ramped up to the maximum of 95 billion dollars per month in september from 47.4 billion earlier

The thing is just like there’s no strong evidence that many years of qe had the desired effect of sparking inflation it’s unlikely that qt will help temper inflation what it is more likely to do and probably already is doing is to cause havoc in the government bond market the benchmark for all other markets that determine the cost of money for governments companies

And consumers liquidity in the treasury market is worse now than during the early days of the pandemic and the lockdowns when no one knew what to expect similarly implied volatility is measured by the ice bank of america move index is near its highest since 2009 at around 156 and in another unusual development that shows just how dysfunctional the treasury market

Has become the newest most liquid securities known as on the run notes traded as a discount to older tougher to trade off the run securities according to recent data daily swings and interest rate swaps have become extreme providing further evidence of disappearing liquidity what should be most concerning to other fed in the treasury department is deteriorating

Demand at u.s debt auctions a key measure called the bid to cover ratio of the government’s last offering on wednesday of 32 billion dollars in benchmark 10-year notes was more than one standard deviation below the average for the last year demand from indirect bidders generally seen as a proxy for foreign demand was the lowest since march 2021 on although the

Treasury is in no jeopardy of suffering a failed auction lower demand means the government is paying more to borrow all of this is coming at the time when the biggest most powerful buyers of treasuries from japanese pensions and life insurance to foreign governments and u.s commercial banks they’re all pulling back at the same time we need to find a new marginal

Buyer of treasure as essential banks and banks overall are exiting stage left the u.s bond market which sets the tone for debt markets worldwide is hardly a loan the russian in uk guilts the last two weeks laid bare the liquidity crisis bubbling in most major sovereign debt markets and from the fed’s perspective it’s probably hesitant to tinker with qt for fear

Of being seen as more concerned with bailing out wall street fat cats than turning inflation but again qe and qt have been shown to have more of an impact on the smoothing functioning of the financial system than the real economy and it’s not like the fed hasn’t tweaked its qt program before to address disruptions in the markets plumbing remember that in 2019 the

Central bank did hold qt and flooded the banking system with cash to arrest the large and unsettling rise in repo rates that led to undue stresses there another option would be for the fed to use its standing repurchase facility to provide the liquidity backstop to the treasury market which yellen has said can be helpful the thinking among market participants is

That the fed will keep raising rates until something breaks but that’s something increasingly looks like it may be the treasury market which will be the worst case for lario on anyone’s scorecard and whether it’s in the us with the spillover effects or another market it doesn’t really matter because the international financial planning is wildly connected so no

One economy can ignore what’s going on in the bonds market and of course the bond markets set the rate for almost all other financial instruments whether you’re talking mortgages corporate debt or indeed government debt so this is a crisis in the making and has the potential to break something serious we must watch him wait i’m martin north from digital finance

Analytics may thanks for watching and i’ll see you again next time foreign

Transcribed from video
Breaking The Bond Market – The Crisis Is Real! By Walk The World