Fed can't keep the rates low

[muscleman]

2 hours ago, wabuffo said:

No - I don't think the TGA balance will continue to run down.   I think the TGA balance will become subordinate to managing to the debt limit, spending, receipts.

 

As to interest rates - I think the trend will be higher but I wouldn't use the word "spike".  There's a lot of liquidity in the system that new Treasury issuance will have to sop up.  The rate at which that happens will depend on the debt ceiling amount and how much future spending Congress passes through the rest of year.   If debt ceiling is raised really high and the Democrats pass both of their "infrastructure plan" - rates could rise at a quicker pace than if the debt ceiling is only raised a limited amount and nothing passes in Congress - then rates would rise rather slowly or go sideways until the Fed stops its QE.

 

There are so many variables in the macro economy that its tough to make calls with certainty.  But the TGA drawdown was a one-time special cause that one could see was having a disparate impact on rates. 

 

wabuffo

 

Thank you so much! I really appreciate it!

[wabuffo]

Brief Update:

 

- no debt ceiling deal was reached by Congress and they are now going on August recess.

 

- Debt ceiling snapped back in place yesterday.  We don't have the Daily US Treasury Statement from Friday yet (it comes out today at 4pm).   I don't think Yellen hit her goal (either the original goal to get to the level the TGA was back in Aug 1, 2019 or her revised goal of $450b).   I think it will end up just slightly under $500b based on Thursday's balance. 

 

- the US Treasury is now limited to $28.4t gross debt outstanding (note this includes intra-govt debt ("social security lockbox"). 

 

- so, US Treasury must now keep to this target (ie debt issuance = debt redemption) while continuing to run the TGA down in the absence of a deal.  Depending on spending requirements (Sept is a corporate tax receipt month) - Yellen can probably go until Sept (maybe early Oct) before TGA balance goes to zero.

 

- this basically extends the treasury yield compression (and yields are compressing today!).   They will continue to likely compress until a deal is reached.  Yellen has some tricks she can pull (reduce the intra-govt portion while raising the public portion of the debt ceiling) but not a whole lot of wiggle room.

 

- of course, this can all end on a moment's notice if a deal to raise the debt limit is reached.

 

It's all so counter-intuitive... any other country threatening to default on its sovereign debt and the yields on its securities would rise.   The US threatens to default and yields on its securities plummet.

 

LOL.

 

wabuffo

 

 

Edited August 2, 2021 by wabuffo

[muscleman]

58 minutes ago, wabuffo said:

Brief Update:

 

- no debt ceiling deal was reached by Congress and they are now going on August recess.

 

- Debt ceiling snapped back in place yesterday.  We don't have the Daily US Treasury Statement from Friday yet (it comes out today at 4pm).   I don't think Yellen hit her goal (either the original goal to get to the level the TGA was back in Aug 1, 2019 or her revised goal of $450b).   I think it will end up just slightly under $500b based on Thursday's balance. 

 

- the US Treasury is now limited to $28.4t gross debt outstanding (note this includes intra-govt debt ("social security lockbox"). 

 

- so, US Treasury must now keep to this target (ie debt issuance = debt redemption) while continuing to run the TGA down in the absence of a deal.  Depending on spending requirements (Sept is a corporate tax receipt month) - Yellen can probably go until Sept (maybe early Oct) before TGA balance goes to zero.

 

- this basically extends the treasury yield compression (and yields are compressing today!).   They will continue to likely compress until a deal is reached.  Yellen has some tricks she can pull (reduce the intra-govt portion while raising the public portion of the debt ceiling) but not a whole lot of wiggle room.

 

- of course, this can all end on a moment's notice if a deal to raise the debt limit is reached.

 

It's all so counter-intuitive... any other country threatening to default on its sovereign debt and the yields on its securities would rise.   The US threatens to default and yields on its securities plummet.

 

LOL.

 

wabuffo

 

 

 

Thank you so much for the insight!

I actually closed my small TLT put position earlier today as I see the chart to be setting up for another leg up, and I thought, well, I really should be trading on the charts than trading on the predictions. It still sucks to have a small loss but that is entirely my fault. I get punished whenever I got off discipline.

 

[muscleman]

https://www.wsj.com/articles/janet-yellen-announces-measures-to-avoid-breaching-debt-ceiling-11627936540?mod=hp_lead_pos12

I can't see this article. Anyone?

[lnofeisone]

19 minutes ago, muscleman said:

https://www.wsj.com/articles/janet-yellen-announces-measures-to-avoid-breaching-debt-ceiling-11627936540?mod=hp_lead_pos12

I can't see this article. Anyone?

Summary: The Treasury Department will begin a debt-issuance suspension period on Monday and will suspend investments in retirement funds for civil servants and postal workers. The funds will be made whole once the debt limit is either suspended or increased.

[gfp]

They got the TGA balance down to $459 Billion - close enough and closer than I thought they would get

https://fsapps.fiscal.treasury.gov/dts/files/21073000.pdf

[muscleman]

18 hours ago, lnofeisone said:

Summary: The Treasury Department will begin a debt-issuance suspension period on Monday and will suspend investments in retirement funds for civil servants and postal workers. The funds will be made whole once the debt limit is either suspended or increased.

 

Thank you. A suspension of debt issuance means the supply of T-bills are disrupted. So price could go higher.

Also it seems like a lot of commodity prices are coming down after reopening. Lumber for example. So the pressure for inflation has eased.

Watch out for the Copper/Gold ratio as that seems to be in correlation with the rates. Copper seems to be forming a top right now. Massive Copper short futures positions were built last week by the commercial traders (smart money).

[Cigarbutt]

On 7/20/2021 at 7:10 PM, Munger_Disciple said:

I found the paper on QE published by UK Parliament to be quite informative: 

https://publications.parliament.uk/pa/ld5802/ldselect/ldeconaf/42/4202.htm

Thanks. That was interesting.

Along the same lines, here's a short read on negative interest rates.

The piece was written by a bright physicist and, perhaps, this is the most important message.

The Incredible Upside-Down Fixed-Income Market (cfainstitute.org)

[Munger_Disciple]

8 hours ago, Cigarbutt said:

Thanks. That was interesting.

Along the same lines, here's a short read on negative interest rates.

The piece was written by a bright physicist and, perhaps, this is the most important message.

The Incredible Upside-Down Fixed-Income Market (cfainstitute.org)

Thanks Cigarbutt. The manuscript looks interesting; will check it out. 

[muscleman]

Hi Wabuffo,

    What's your take on the reverse repo situation now? Does this have a cap, or will it go up for any indefinite amount? If this has a cap, then will we have negative rates?

 

 

Thank you!

    

 

 

[wabuffo]

Does this have a cap, or will it go up for any indefinite amount? If this has a cap, then will we have negative rates?

 

Does not really have a cap b/c it's within the Fed's power to expand the number of participants as well as expand the limit per participant.  (right now there's like 100 potential participants and each has an $80b limit - so do the math; we are far from the current max capacity)

 

US can't have negative rates because of this 5bp reverse-repo regime by the NY Fed.   Remember my bathtub analogy - the reverse repo is the bathtub overflow drain.  If there was no overflow drain - then, yes, one could see negative rates.  But right now there's basically a 5bp "floor" to short-term rates.

 

The falling rates should level off soon and start to slowly go back up when two things happen:

 

1) the debt ceiling is raised - maybe mid-Sept? but not before some high drama in Congress and the US Treasury hitting zero balance in its TGA at the Fed.

 

2) the Fed will stop its buying of Treasuries soon - also maybe Sept.  This does not mean it reduces its holdings - it will just roll over its redemptions with new purchases and keep its ownership level flat.

 

wabuffo

[muscleman]

On 8/13/2021 at 12:53 PM, wabuffo said:

Does this have a cap, or will it go up for any indefinite amount? If this has a cap, then will we have negative rates?

 

Does not really have a cap b/c it's within the Fed's power to expand the number of participants as well as expand the limit per participant.  (right now there's like 100 potential participants and each has an $80b limit - so do the math; we are far from the current max capacity)

 

US can't have negative rates because of this 5bp reverse-repo regime by the NY Fed.   Remember my bathtub analogy - the reverse repo is the bathtub overflow drain.  If there was no overflow drain - then, yes, one could see negative rates.  But right now there's basically a 5bp "floor" to short-term rates.

 

The falling rates should level off soon and start to slowly go back up when two things happen:

 

1) the debt ceiling is raised - maybe mid-Sept? but not before some high drama in Congress and the US Treasury hitting zero balance in its TGA at the Fed.

 

2) the Fed will stop its buying of Treasuries soon - also maybe Sept.  This does not mean it reduces its holdings - it will just roll over its redemptions with new purchases and keep its ownership level flat.

 

wabuffo

 

Thank you!

If covid cases start to get out of control, do you think that may impact this?

[muscleman]

https://fsapps.fiscal.treasury.gov/dts/issues

335Bn as of August 13th. That's going down quickly.

[Spekulatius]

Balance down to $258B on 8/25. I think we have probably a month to go until this goes to $100B and I am sure they don't run this all the way to zero.

After that, they need to issue treasuries again at the same rate than the deficit, which is a ~$250B monthly rate.

[wabuffo]

After that, they need to issue treasuries again at the same rate than the deficit, which is a ~$250B monthly rate.

 

Yellen has said that when the debt ceiling is raised, she intends to more or less immediately go back up to a $750b target balance on the Treasury's general acct (TGA) at the Fed.   That is going to mean a big slug of new Treasury security issuance (in addition to the $250b or so per month to maintain the TGA level).

 

All we need is for the Fed to slow down/stop its Treasury security buying and that will significantly affect the growth of US Treasury security inventory in the private sector's hands.

 

For comparison purposes (Tsy debt held by the public - Tsy debt held by the Fed = Net Tsy Debt held by the private sector):

 

8/25/21:    $22.249t - $5.346t = $16.903t

3/10/21:    $21.786t - $4.889t  = $16.927t

IOW, there has been ZERO growth in private sector inventory of Treasury securities since early March (mainly due to the liquidation of the US Treasury general acct but also due to Fed open market buying).

 

But - there has been $1.6t in deficit spending in that exact same time period creating bank reserves (from flows from the TGA acct to the commercial banking sectors accts at the Fed) with no net Tsy issuance to soak those reserves up. 

 

This shows the urgent necessity of the Fed kick-starting its reverse repo in mid March 2021 which went from zero to $1.1t.  Add in $500b growth in bank reserves since that time and that reconciles with the $1.6t in deficit spending as offsets. 

 

The reverse repo probably kept interest rates from collapsing completely and dragging the US into negative interest rate territory.

 

BTW - this little real world exercise kind of proves two key things that are actually the opposite of what the economics profession teaches as conventional wisdom:

 

1) Large amounts of Treasury deficit spending causes lower interest rates - not higher interest rates as economists profess.  That's because without security issuance, the private sector accumulates too much in reserves with no need for them.

 

2) Treasury borrowing is a reserve drain which functions to support interest rate targets and as such is not borrowing as we normally think of it.  Treasury security issuance ("borrowing"), instead, is an interest rate maintenance mechanism.

 

wabuffo

Edited August 27, 2021 by wabuffo

[hasilp89]

@wabuffo i've read this 7 times and think i might actually understand it (probably not though). Is this rough understanding even directionally correct?

 

Treasury deficit spent -> created reserves at banks -> treasury didn't issue tsy securities in conjunction with the deficit spend so banks had nothing to do with reserves -> excess reserves at banks created potential for negative rates -> fed stepped in with reverse repo to prevent this.

 

you mentioned the $1.6t of deficit spending and noted the accounting - while i can kind of see how the ledgers transaction works I'm confused on how it was in the TGA acct in the first place? Is that $1.6t just created because congress said so? Was their tsy security issuance in the past to raise that money?

 

1 hour ago, wabuffo said:

All we need is for the Fed to slow down/stop its Treasury security buying and that will significantly affect the growth of US Treasury security inventory in the private sector's hands.

Does this just mean that rates are going to need trend higher for the private sector to be willing to hold more tsy securities?

[wabuffo]

Treasury deficit spent -> created reserves at banks -> treasury didn't issue tsy securities in conjunction with the deficit spend so banks had nothing to do with reserves -> excess reserves at banks created potential for negative rates -> fed stepped in with reverse repo to prevent this.

 

 

Just think of the Fed as a bank.  The US Treasury has an account there, so does every Federally-chartered bank.  Then just do the debits and credits into & out of those Fed "bank" accounts and you already understand this better than almost everyone on CNBC.

 

I'm confused on how it was in the TGA acct in the first place? Is that $1.6t just created because congress said so? Was their tsy security issuance in the past to raise that money?

 

Well yes - Congress has the power of the purse.  So the US Treasury can't spend on anything unless it has Congressional authorization to do so.  But in 2019, the debt ceiling was temporarily suspended for two years.  So as the pandemic broke, the US Treasury took advantage and issued a bazillion dollars of US Treasury securities.  This was fortunate - because in the very early days of the pandemic, the whole world was rushing to the safety of the safest asset in the world - so demand was very high.

 

It's important to note that the US Treasury faces political constraints - not economic or practical constraints.  These political constraints confuse everyone into thinking that the US Treasury is like you or me.

1) Political constraint #1:  US Treasury can't overdraw its TGA (ie, maintain a negative balance) at any time.

2) Political constraint #2:  US Treasury can't have more US Treasury securities outstanding than the level mandated by Congress ("the Debt Ceiling")

 

But in reality none of these are real constraints.  For example, the Fed used to allow the banks to overdraw their reserve accounts during "daylight hours" as payment clearing between banks happened.  IOW, JP Morgan could start the day with $5b in its reserve account, drop down to as low as negative $100b at mid-day as it cleared payments from its customers' accts and end up back at $5b by the end of the day as it received payments into its customers's accts.

 

Hope this helps.  It took me years to figure this all out but eventually the penny drops....

 

wabuffo

 

[Guest]

So does all of this mean we're still (probably) going to have low interest rates over the short-intermediate term?

[wabuffo]

So does all of this mean we're still (probably) going to have low interest rates over the short-intermediate term?

 

I don't know about timing - but the next chapter will happen when the debt ceiling is lifted.  There's a chance that the US Treasury's acct at the Fed goes to zero (now down to $239b) before Congress does anything.   I really thought it would've been resolved by now.

 

wabuffo

Edited August 27, 2021 by wabuffo

[KJP]

wabuffo:  Thanks for all of your contributions in this thread.  I've found them compelling and persuasive and, more importantly, they seem to correctly predict what's happening.

 

But I have a question:  Under current law, the Fed is not permitted to simply directly credit the Treasury's account, correct?  In other words, under current law, the United States (in the form of the Federal Reserve) cannot just print money and give it to itself (in the form of the Treasury's account at the Fed).  Instead, the Treasury account must be funded in the first instance via tax revenue and debt issuance, and then the Fed can buy that debt from private parties, correct? 

 

If that's right, then what you describe as "political constraints" are also currently binding legal constraints.  Of course, Congress could change the law, so perhaps it's fair to describe these legal constraints as merely political constraints. 

 

The reason I'm asking is that I have heard others (e.g., Lacy Hunt) describe the potential legal change I refer to above as a type of "crossing of the Rubicon" that could actually cause significant and generalized inflation.  But is that type of inflation (as opposed to inflation in asset prices) even in such a scenario consistent with your theory?  If the Fed could directly credit the Treasury's account, that would seem to lower the amount of Treasuries that would otherwise be in the system and raise the amount of bank reserves as the Treasury spends down the dollars digitally "printed," and they pile up as excess bank reserves. 

Edited August 27, 2021 by KJP

[wabuffo]

But I have a question:  Under current law, the Fed is not permitted to simply directly credit the Treasury's account, correct? 

 

KJP - I am far from an expert in this area or in the history of the interactions between the Fed and the US Treasury, ....buuut....I did stay at a Holiday Inn Express last night!

 

The short answer is that the Fed can't do this anymore.  Congress has mandated that the Fed can only conduct open market operations involving US Treasury securities.  I should've added that as political constraint #3.

 

It is strange because people always perceive the "stronger" entity being the Fed with the weaker one being the US Treasury.  But it's actually the other way around.  For one, the Fed is "owned" by the US Treasury.  I mean, literally, the equity account of the Fed is owned by the US Treasury.   Second, it is the US Treasury that owns the mint that prints the bank notes and coins.  If a bank asks the Fed for a delivery of banknotes, the Fed can't do this itself and has to call the US Treasury.  The Fed just handles the accounting (removes a reserve balance from that bank to pay for the currency being sent to said bank).   How about that, eh?  Jerome Powell doesn't even own the printing press, the US Treasury does!  So much for money printer go brrrrrr meme!

 

Finally in extreme situations, its the US Treasury that will directly issue "cash bills" to the Fed in return for a reserve deposit in the TGA (despite constraint #3 above).  We saw this during the beginning of the GFC in September 2008.  Here was the press release from the US Treasury (and not the Fed):

 

https://home.treasury.gov/news/press-releases/hp1144

 

Note this is exactly what would drive Lacy Hunt into his bunker full of canned foods and shotguns.  The Fed is "lending" reserves to the US Treasury in exchange for T-bills!   Aye caramba!   But it's the Fed that was in trouble here.  The crisis was causing it to swap so much of its Treasury securities out to banks who desperately needed collateral, that it feared running out (ah the days of a Federal Reserve with a tiny balance sheet!).

 

Now at first, the reserve funds given to the US Treasury were 'segregated' to a separate Treasury reserve account to give a fig leaf of cover that this was a temporary measure. 

 

 

But eventually the fig leaf was removed and the "funds" commingled.  But notice who creates the "assets" out of thin air.  It"s the US Treasury - and I think that's what everyone doesn't understand.  In fact, we saw this again during the pandemic.  The US Treasury added more "equity" to the Fed's balance sheet so that the Fed could do some of its special "lending programs".

 

So there are two important conclusions here: 

1) As I always say - the Fed can only swap financial assets, it is only the US Treasury that can create new financial assets out of thin air.  It is the 800-lb gorilla, the Fed is just that small man behind the curtain.  Pay no attention to him. 

 

2) There is no Rubicon to cross.  The US Treasury is not practically or physically limited.  It is only politically limited by Congress.  But as we've seen in the above example, since Congress controls the power of the purse, it can and will change the rules when it needs to.   Thus if one is worried about deficit spending leading to inflation, then worry away 24-7 and don't concoct bizarre scenarios of how the Fed can release the US Treasury to cross a river in Italy.  In fact, Lacy Hunt needs to get more imaginative, since the best one I heard was the truly bizarre scenario of minting a trillion dollar platinum coin*.

 

BTW - I am truly impressed that y'all continue to be interested by this boring stuff!  Thanks for engaging and letting me ramble.

 

wabuffo

 

*this was an actual scenario floated by some legal experts from the left during one of the many US debt ceiling cliffs years ago.   Since, as we've seen, the US Treasury mints all the currency (and this is not limited by the debt ceiling), the Fed could ask for a trillion dollar platinum coin to be minted.  The US Treasury would then trade it to the Fed (who I guess would put in Fort Knox?) and the Fed would credit the US Treasury's general account with $1 trillion in shiny new reserves.   See - a loophole where the US Treasury funds itself without issuing debt in contravention of the debt ceiling.   Such silliness...

 

https://en.wikipedia.org/wiki/Trillion-dollar_coin

Edited August 28, 2021 by wabuffo

[hasilp89]

yellen sounding the alarm on october debt cliff. 

 

https://www.politico.com/news/2021/09/08/yellen-october-debt-cliff-congress-510442 

[Spekulatius]

^ Yes, the checking account balance is ~$230B. That's only enough for a few weeks if the debt limit issue isn't addressed. Drama to be expected.

Edited September 9, 2021 by Spekulatius

[wabuffo]

The debt ceiling drama appears to be temporarily over - and you can see it in the last few US Treasury Daily Statements.  From a low general account balance at the Fed of $46b, the US Treasury is quickly ramping it back up to $135b in just 2 days (Friday last week and Monday).   It is doing this by rapidly issuing more US Treasury securities than it is redeeming over and above its normal deficit spending. 

 

Of course, another debt ceiling crisis may still unfold in December, but I think US Treasury yields are going to start running higher.   The commentators on CNBC will be confused as to why and wondering if its due to inflation or bond market "vigilantes", etc.  But the real reason will have been the weird dynamics in 2021 of the US TGA drawdown.

 

I have put on all of my TLT LEAP put positions (last one of the batch was on Monday) and will just ignore the Fed and US Treasury from here on in.  It's always possible there will be another mini run-down of the TGA balance if Congress again plays games of chicken - but they will eventually raise the limit again (and again....and again).   With the Fed also likely to pull back its aggressive buying soon, this will be interesting to watch.

 

Fun stuff for us monetary plumbing nerds.

 

wabuffo

Edited October 20, 2021 by wabuffo

[no_free_lunch]

We are looking to upgrade our home and will be getting a mortgage.  Curious peoples thoughts on variable vs fixed rates and this thread seemed relevant. These are my options, keep in mind I'm in Canada so no 30 year mortgages, I wish.

 

5 year variable 1.3% rate.

5 year fixed 2.2% rate.

 

The variable is very tempting but I'm concerned what happens if rates start spiking. They would have to raise 100 bp before we lose with variable but who knows we are at historical lows.