UST PROFITABILITY AND SYSTEM LIQUIDITY HAVE NOT CHANGED MUCH YET. HOWEVER, EXPECTATIONS TOWARDS YEAR-END ARE ALREADY IMPACTING POSITIONING.

Alexander Ovchinnikov

Sep 9, 2023

The Fed continues to reduce the volume of assets on its balance sheet — minus $20 billion over the past week, and since the beginning of the year, the balance has decreased by $449.8 billion. As can be seen, the Central Bank is still lagging behind its schedule, and the planned pace of asset reduction over the past eight months should have led to a loss of $760 billion. However, we have what we have, taking into account the mini-banking crisis in March-April and the Fed's efforts to stabilize the system. On its part, the Treasury also slightly increased the balance of funds in its operating account over the week, bringing it to $482 billion. At the same time, compared to the data at the end of August, the account balance decreased by $60 billion. Considering such a negligible impact from the Fed and the Treasury, it can be said that their operations could not have a noticeable impact on the liquidity of the system as a whole, nor on the behavior of market participants. Indeed, the volume of reverse REPO operations by banks with the Fed has remained on average about $1.57 trillion since the beginning of the month (and the volume of open positions on call options on the S&P 500 index, having sharply fallen in early August, also remains approximately at the same level). What is really in focus is the Treasury's operations in the government debt market to finance the budget deficit, as well as how these operations may affect bond yields along the curve further. In August, the Treasury indeed significantly increased the volume of securities offered in the primary market. However, this was largely due to an increase in debt servicing costs to $1.98 trillion compared to $1.5 trillion in July. As a result, the Treasury increased the offer of securities in August to $2.32 trillion compared to $1.75 trillion in July. The net volume of funds raised increased to $333 billion compared to $246 billion a month earlier, but not 'horror-horror.' In addition to the increase in payments for debt servicing, the Treasury's position may also be affected by growing risks of a partial government shutdown from early October if parties in Congress fail to agree on budget expenditures (during the beginning of the election campaign).

How does this affect rates? Remaining on a 'dry ration' in May, but receiving a budget agreement and an increase in the government debt limit until January 2025 in early June, the Treasury actively borrowed in the market — the net volume of funds raised soared to $550 billion by the end of June, and the yield on 10Y UST rose by 20 bps. In July, the yield on securities increased by another 12 bps, and in August at some point rose by another 38 bps, to 4.34%. At the same time, the Treasury continues to report on borrowing terms: reports show that the priority is still on short-term securities (85.7% in August). Even with the high supply from the issuer, rates at the short end of the curve do not exceed 5.5% — all the supply is being bought up. As for long-term rates (the most important question for an investor — where they will be), here it is worth comparing the influence of several trends at once. First of all, long-term rates are expectations for the economy. And here we see signs of a slowdown in the US and eurozone economies (which regulators are actually aiming for and openly talking about), and the Chinese economy does not look like a standalone success story. Moreover, if risks increase, liquidity dries up, and the stock market takes a confident 'course to the South,' all this will be reflected in the yield of long-term treasury securities, which may be noticeably below 4.0%.