Manipulating long treasury yields lower wont necessarily boost the economy
February 16, 2025 – Weekly Comment
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A friend sent me a link to the latest MacroVoices which this week featured Jim Bianco (thanks DDK). The beginning 5 minutes or so is Bianco’s excellent summation of a proposal that’s being called the Mar-a-Lago Accord. A rough outline is that Treasury would issue 100-year bonds that pay no interest. Foreign countries which hold US Treasuries and benefit from US Defense services, would be invited swap their interest-bearing treasuries with the new bonds, essentially paying for defense services by foregoing interest. (No swap, no defense). The Fed could then set up swap lines for any country needing liquidity, and would accept the zero interest bonds as collateral at par.
As mentioned last week, long dated swap spreads continued to surge as regulators are likely on the verge of loosening Supplementary Leverage Ratio (SLR) and G-SIB surcharge rules. (RTRS) “In April 2020 the Fed temporarily excluded treasuries and central bank deposits from the SLR to boost liquidity… But it let the exclusion expire the following year.”
From Fed’s Michelle Bowman speech Feb 5, “Where we can take proactive regulatory measures to ensure that primary dealers have adequate balance sheet capacity to intermediate Treasury markets, we should do so. This could include amending the leverage ratio and G-SIB surcharges…”
From a 2024 ISDA letter to the Fed, FDIC and Comptroller of the Currency:
To facilitate participation by banks in U.S. Treasury markets—including clearing U.S. Treasury security transactions for clients—the Agencies should revise the SLR to permanently exclude on-balance sheet U.S. Treasuries from total leverage exposure, consistent with the scope of the temporary exclusion for U.S. Treasuries that the Agencies implemented in 2020.
Obviously, with massive deficits and the administration seeking to get long-term yields down, it’s important for US banks to absorb UST issuance. A permanent exclusion of SLR rules dovetails with this goal. While it might lessen costs for the US Gov’t, rates on private debts may not see as much relief, but I suppose, at the margin, the ‘crowding out’ effect is reduced.
I did not read the paper, but ZH quotes BofA’s Hartnett: “…rising inflation means Trump in coming months has to go ‘small’ not ‘big’ on tariffs and immigration to avoid fanning 2nd wave of inflation.” Personally I think that’s wrong. Trump is looking to alter incentives, not at the margin but at the core of the system. If it results in some wrenching short-term pain, I think the administration is willing to pay that price, even if stocks falter. Better to take the pain early. I refer once again to Nayib Bukele’s speech on taking decisive action to change incentives:
https://www.facebook.com/nayibbukele/videos/522919087190090/
The MOVE chart below is, perhaps, a reflection of confidence in that idea. Bond vol is dropping. I would note as well that VIX at 14.77 is nearing the lower portion of its range.
Market color
CPI was higher than expected. Retail Sales were weak. The NY Fed’s Consumer Credit report shows that Flows into Serious ( > 90 days) Delinquency on all categories of Consumer loans edged up in Q4, except Student Loan Debt. Mortgages from 0.82% in Q3 to 1.09% in Q4. Auto Loans 2.66% to 2.96%. Credit Cards 6.36% to 7.18%. Conclusion that some analysts are drawing: Stagflation.
Yields ended little changed on the week. On the SOFR strip the largest decline was SFRH5 at 9569.25, down 2.75. The largest gains were SFRZ5, H6 and M6 all up 2.5, prices of 9602, 9606 and 9608. Due to inflation concerns, near contracts are gravitationally pulled down towards the Fed Effective rate of 4.33%, as the Fed is expected to hold steady in the near term. The peak SOFR contracts are closer to 4% reflecting a modest adjustment over time towards the neutral rate. The ten-year yield was nearly unchanged despite auctions, ending 4.48%. Though inflation expectations have increased, the market is looking past these concerns. Last week’s price action simply indicates that a possible acceleration in inflation has been dismissed. The big question is whether the US economy surges due to relaxed regulatory burdens and new domestic investment in energy and manufacturing. Or whether tariffs, an immigration crackdown and decelerating gov’t spending tip the country towards recession. Over the short term, I lean towards the latter and over the longer term, the former.
Regarding SOFR option plays, I personally favor long call spreads, though the 9562.5/9537.5ps in SFRU5 for 1.75 was a popular buy last week. (Settled 1.5 vs 9594.0). This post from George Austin at Pricing Monkey sums it up:
Heavy options skew in SFRU5 (Sept SOFR) centred around 4.37%.
If you need a hedge for a rate hike, put strategies are cheap with the skew (see lower chart).
For upside exposure, call spreads, flys, and condors are all near the bottom of their price ranges, making them attractive plays in this skewed environment.
Friday is March treasury option expiration. Peak open interest is TYH 108.5c with 179k open; settled 55 ref 109-10. These calls were originally purchased in size vs futures, when they were just out-of-the-money. Currently, the 108.5p is just 3/64s. The 109p, which has been heavily jobbed around in the past week or so, settled 9 and has 90k open. I would expect futures to edge toward the 109 strike going into expiry.
(This note is NOT intended as financial or trading advice).
| 2/7/2025 | 2/14/2025 | chg | ||
| UST 2Y | 427.7 | 425.5 | -2.2 | |
| UST 5Y | 433.1 | 432.7 | -0.4 | |
| UST 10Y | 448.0 | 447.4 | -0.6 | |
| UST 30Y | 468.1 | 469.4 | 1.3 | |
| GERM 2Y | 204.8 | 211.3 | 6.5 | |
| GERM 10Y | 237.2 | 243.1 | 5.9 | |
| JPN 20Y | 196.6 | 201.3 | 4.7 | |
| CHINA 10Y | 160.6 | 165.0 | 4.4 | |
| SOFR H5/H6 | -31.5 | -36.8 | -5.3 | |
| SOFR H6/H7 | -2.0 | -1.0 | 1.0 | |
| SOFR H7/H8 | 4.5 | 5.5 | 1.0 | |
| EUR | 103.30 | 104.93 | 1.63 | |
| CRUDE (CLJ5) | 70.74 | 70.71 | -0.03 | |
| SPX | 6025.99 | 6114.63 | 88.64 | 1.5% |
| VIX | 16.54 | 14.77 | -1.77 | |
| MOVE | 93.13 | 84.67 | -8.46 | |
https://www.isda.org/a/h3sgE/ISDA-Submits-Letter-to-US-Agencies-on-SLR-Reform.pdf
