iFlow > Short Thoughts
Published on Tuesdays, Short Thoughts offers perspectives on US funding markets, short-term Treasuries, bank reserves and deposits, and the Federal Reserve's policy and facilities.
John Velis
Time to Read: 4 minutes
EXHIBIT #1: SMALL TERM PREMIUM DECLINE, MOSTLY RETRACED
Source: BNY Markets, Bloomberg
It’s been less than a week since the U.S. Department of the Treasury announced an increase in its liquidity-supporting buyback operations for longer-dated nominal coupon securities. After an initial, modest rally at the back end of the curve, yields aren’t far from where they started at Wednesday’s open, before the announcement. The 30y bond, which offered a yield of 5.31% on last Tuesday’s close, dropped to 5.19% on Wednesday and is now back over 5.20%. Term premia across the longer end of the curve, which also fell last Wednesday has almost fully returned what it initially shed. This rally and retrenchment suggest that the maneuver had limited direct effects on the market beyond the initial impact of the announcement.
EXHIBIT #2: LIQUIDITY WASN’T ESPECIALLY CHALLENGED PRE-ANNOUNCEMENT
Source: BNY Markets, Bloomberg, internal data*
*We show depth of book in 10y bond equivalents according to data from BNY’s Treasury trading desk.
Since they were started in 2024 by then Treasury Secretary Janet Yellen, UST buybacks have been ostensibly framed as liquidity support to the market, and last week’s announcement positioned the extension as such. It’s not clear to us that there was a liquidity issue in the long-dated coupon section – our in-house metric showed no significant drop in depth of book last week, nor did Bloomberg’s widely followed U.S. government liquidity index (see Exhibit 2).
Recent press reports have suggested that the Treasury General Account (TGA) could finance the buybacks going forward. Currently well over $900bn, it has fluctuated around the $850bn level over the past 12 months, broadly adhering to Treasury’s stated guidance, which targets $850bn for the year-end cash balance. This suggestion is interesting, particularly on the back of recent discussions, which entertain deploying TGA funds into repo when spreads are attractive and cash in the TGA is excessive. How these two policies – reinvesting TGA funds in repo and using them to pay for bond buybacks – would coexist is an open question.
It further implies that if Treasury is really committed to keeping the TGA around $850bn through the end of the year, then T-bill issuance will ultimately fund the buybacks, leaving the operation fiscally neutral – where the size of the debt doesn’t change, just its composition – but reducing bank reserves, all other things held equal. Granted, $12bn or even $24bn or so from the TGA going into the long end of the curve won’t change TGA levels dramatically, but it still implies that at some point, the buybacks will be funded by T-bill issuance.
EXHIBIT #3: CROSS BORDER UST FLOWS FELL ON THE ANNOUNCEMENT
Source: BNY Markets, iFlow
The brief rally and retrenchment in both yields and the term premium suggest that the operation, while potentially addressing a liquidity issue that may or may not exist, did little to change the overall negative tone at the long end of the curve. If the goal of the buybacks is to help contain long-end rates, then this maneuver looks to be too small in scope, and unlikely to alter the fundamentals that have led to higher yields at the back end in the first place. Fiscal concerns, waning foreign demand, increased demand for capital due to the AI capex story, and potential credibility concerns have weighed on long yields for some time now, and these considerations haven’t receded. Fundamentals matter. Interestingly, as Exhibit 3 shows, cross-border investors actually sold Treasurys on August 19, the day of the announcement, and demand hasn’t recovered since.
We view this development as dollar negative, not least because financing buybacks from the TGA would read to markets as fiscal expansion pushing the dollar lower. Furthermore, this “light” version of Operation Twist could result in further credibility concerns, especially if the action doesn’t materially alter the yield levels. Gold has rallied, almost mirroring broader dollar movement, reflecting those credibility concerns, especially the Treasury’s commitment to “regular and predictable” issuance across the curve. Indeed, if the operation doesn’t achieve its aim – which again, we’re told is liquidity support, but we infer is something more ambitious – the debasement trade could accelerate.
One of the final big events of the summer occurs this Friday in Jackson Hole, Wyoming, where Fed Chair Kevin Warsh is scheduled to deliver remarks at the Kansas City Fed’s annual symposium. Not surprisingly, we don’t expect much guidance from the Chair regarding the rates outlook, but it will be difficult to avoid talking about the latest Treasury action, which is at least one of the elephants in the room. How this maneuver brushes up against Warsh’s stated desire to shrink the balance sheet is unclear.
The Friday morning speech is often seen as the Chair’s opportunity to lay out the policy path, particularly if there is a change of bias afoot or if there are important operational or policy announcements to share. We don’t expect this to be one of those times, given Warsh’s reticence when it comes to forward guidance. We think that while the audience and the market would like something concrete to take away from his appearance, Warsh will more likely speak generally about his ambitious reform agenda, and the reason why each task force (Inflation Frameworks, Data, Communications, Balance Sheet Policy, and Productivity and Jobs) is crucial.
Moving beyond whatever surprises Jackson Hole may provide (or not), the rates view hasn’t changed. We still don’t expect any change in policy this year and think that the inflation picture will continue to slowly ease, obviating the need to tighten policy. As we approach the U.S. Labor Day holiday and the end of summer, we’ll have one more jobs report and one more CPI report to digest going into the September FOMC. We expect the signal from these data releases to further ease the hawkish pressure currently seen in the market.
