Speaker 1: Bloomberg Audio Studios, Podcasts, Radio News.
Speaker 2: Hello and welcome to another episode of the Out Thoughts podcast.
Speaker 2: I'm Tracy Alloway and I'm Joe Wisenthal. Joe, one of
Speaker 2: the struggles we're having right now is that so much
Speaker 2: is happening, so much has been going on, that it's
Speaker 2: hard enough to keep up with the immediate news, but
Speaker 2: it's especially hard to stop and kind of ponder and
Speaker 2: analyze what just happened. You sort of move on to
Speaker 2: the next thing immediately, right.
Speaker 3: Well, I've always said hindsight is not twenty twenty because
Speaker 3: we all disagree about things that have happened in the past.
Speaker 4: We know that all the time, So I've always hated
Speaker 4: that cliche.
Speaker 3: But at least from the perspective of podcast co hosts,
Speaker 3: talking about the past removes the risk to some extent
Speaker 3: that the episode we're doing is completely.
Speaker 4: Normal immediately going to be out of it by the
Speaker 4: time it's released.
Speaker 2: Yeah, this is true. Okay, So hopefully this episode will
Speaker 2: still be relevant. I think it will be. We're going
Speaker 2: to talk about what happened in the bond market basically
Speaker 2: in April of twenty twenty five. I think that will
Speaker 2: still be relevant. This was one of the biggest, most
Speaker 2: dramatic things that happened in a market that, really, as
Speaker 2: I like to say, is supposed to be pretty boring, right, Like,
Speaker 2: people buy you as bonds because you want that little
Speaker 2: bit of income. You want to know that you're getting
Speaker 2: your money back, You want some certainty. People don't buy
Speaker 2: it because it's moving around a lot on a day
Speaker 2: to day basis. And yeah, that's exactly what we saw
Speaker 2: happen in April post Trump's Liberation Day on April second,
Speaker 2: So we should talk about.
Speaker 3: It totally, in particular the night of April ninth. Now,
Speaker 3: the tenure yield actually peaked on April eleventh. We're recording
Speaker 3: this April twenty fourth. The recent peak was April eleventh,
Speaker 3: But April ninth I will never forget as the night
Speaker 3: that I got zero sleep because I was just refreshing
Speaker 3: my Bloomberg gap on the couch because I just was
Speaker 3: watching this yield spike and everyone's like, it's China dumping. No,
Speaker 3: it's Japan dumping. No, it's margin calls, and everyone's just
Speaker 3: looking for cash. We need answers for what happened the
Speaker 3: night of April eighth.
Speaker 2: This is already revisionist history, because you're on the record
Speaker 2: saying that you did, in fact fall asleep on your couch,
Speaker 2: and now you're saying you got no sleep.
Speaker 3: So it was late, and the peak was actually, I
Speaker 3: don't know, somewhere in there whatever.
Speaker 2: Points still stands. Stuff was happening in the treasury market,
Speaker 2: and there was a lot of discussion when it was
Speaker 2: happening about what was going on. A lot of people
Speaker 2: reaching for the old bond market boogeyman in the form
Speaker 2: of the basis trade, and then a lot of people
Speaker 2: talking about other things like maybe real money sellers who
Speaker 2: just don't want to be as exposed to US debt
Speaker 2: anymore because of all the uncertainty from Trump and his
Speaker 2: tariff regime, et cetera. So we should talk about it.
Speaker 3: By the way, twelve ten a m. On the morning
Speaker 3: of April ninth was that intermediate peak, So I think
Speaker 3: I was still awake by then.
Speaker 2: Keep going, Okay, now that we've settled the most important
Speaker 2: part of what happened on that particular day, we do,
Speaker 2: in fact have the perfect guest. We're going to be
Speaker 2: speaking with someone who we wanted to get on the
Speaker 2: podcast for a really long time. And shame on us.
Speaker 2: We didn't do it because he's here at Bloomberg and
Speaker 2: he's sort of widely available, so we just kind of
Speaker 2: kept putting it off. But now is the perfect time
Speaker 2: to do this. So we're going to be speaking with
Speaker 2: Ira Jersey. He is, of course, chief Global Interest rate
Speaker 2: strategist for Bloomberg Intelligence, and I'm so glad we can
Speaker 2: finally have him on to talk about everything that's been happening. Iira,
Speaker 2: thank you so much for coming on on lots.
Speaker 5: Thanks very much for having me on. I have to
Speaker 5: admit I am one episode behind, So don't talk about
Speaker 5: your last episode with me, because I'll listen to that
Speaker 5: on my way home today.
Speaker 2: You're saving it for later, Okay, we won't ruin the
Speaker 2: plot of the latest episode. Okay, I guess just a
Speaker 2: color question to start off with, But what have the
Speaker 2: last few weeks been like for you? You know, you're
Speaker 2: the chief rate strategist over at BI. There's been no
Speaker 2: shortage of stuff to write and analyze at the moment.
Speaker 2: How busy has it been and how dramatic is everything
Speaker 2: against your previous experience in bonds?
Speaker 5: Yeah, so we've been talking about this, like, is this
Speaker 5: the busiest couple of weeks that we've ever had, and
Speaker 5: I would go back to the last time that was
Speaker 5: something similar was the September October period of two thousand
Speaker 5: and eight. For me, back in those days, I was
Speaker 5: covering Fanny May and Freddie Mack and obviously they went
Speaker 5: into conservatorship during that period. Then you had the whole
Speaker 5: TARP failure where Congress didn't pass the rescue plan and
Speaker 5: then finally they did, so there were you know, many
Speaker 5: questions about the financial world back then. I think this
Speaker 5: period is a little bit different in that we're talking
Speaker 5: about and you've talked about this on the show already
Speaker 5: over the last few weeks. This is a bit different
Speaker 5: because you're talking about real economy issues as opposed to
Speaker 5: financial economy issues. And because of that, people are wondering, like,
Speaker 5: is there going to be a new world order? What
Speaker 5: does it mean when you get you know, thirty basis
Speaker 5: point spikes in the ten year yield on you know,
Speaker 5: just one tweet. Does that mean that the dollar is
Speaker 5: no longer going to be the reserve currency? These are
Speaker 5: the questions that we continually get and it's difficult to
Speaker 5: say at this point because we don't know what the
Speaker 5: endgame is. But yeah, like you said, Tracy, there's absolutely
Speaker 5: no lack of things to talk about.
Speaker 3: Why would you say this is more uncertain or busy
Speaker 3: than COVID Because then we also saw this big liquidation
Speaker 3: selling in treasuries, We saw an extraordinary effort by the
Speaker 3: FED to come out and stabilize the bond market. What
Speaker 3: is it that puts this more in the category of
Speaker 3: the Great Financial Crisis rather than March twenty twenty.
Speaker 5: Well, I think in March twenty twenty, we all knew
Speaker 5: that there was an issue, and the FED and other
Speaker 5: fiscal agents acted very swiftly because everyone kind of knew
Speaker 5: what the endgame was. We knew that we were going
Speaker 5: to be shut down. We knew that we had to
Speaker 5: figure out some way to live in a world where
Speaker 5: everyone was at home. So I think that that the
Speaker 5: fact that the endgame was kind of understood at the
Speaker 5: time and policymakers acted very quickly because they knew what
Speaker 5: the path would be if they didn't do anything. In
Speaker 5: two thousand and eight, we knew that like, look, if
Speaker 5: TARP didn't pass, what might have happened to the banking
Speaker 5: sector At the time, you just had Leman go under.
Speaker 5: You just had Fanny and Freddie go under. So and yes,
Speaker 5: there was some policy response, but it wasn't enough, Like
Speaker 5: the FED alone wasn't enough to get us out of
Speaker 5: that particular situation. And I think here the issue that
Speaker 5: we have today is there is and we always use
Speaker 5: the term uncertainty, but I think we have to because
Speaker 5: we don't know what the endgame ultimately is, right. We
Speaker 5: don't know is is this the administration's way of getting
Speaker 5: people to the table for things like defense burden sharing.
Speaker 5: Is this the way that for them to get to
Speaker 5: the table to isolate China? Is this the administration's way
Speaker 5: of basically saying that, Hey, we don't know how to
Speaker 5: cut the deficit, so let's focus on international because we
Speaker 5: can do that. And that's in the president's purview as
Speaker 5: opposed to something that Congress has to do. So I
Speaker 5: think that there is a lot of right now uncertainty.
Speaker 5: And I think the moves in the treasury market kind
Speaker 5: of show the fragility of liquidity in the treasury market.
Speaker 5: And there's a lot of reasons for that, and we
Speaker 5: can get wonky. And I've talked about this for over
Speaker 5: a dozen years since the Basil capital rule regulations went
Speaker 5: into effect. But there are a lot of reasons to
Speaker 5: think that we're going to continue to see these bouts
Speaker 5: of volatility in the treasury market because of structural changes,
Speaker 5: and when those structural changes come out like they did
Speaker 5: the last few weeks, you do see these extreme volatility
Speaker 5: events like we did on the seventh of April, Like
Speaker 5: we did on the ninth of April.
Speaker 2: Well, okay, so since Joe brought up twenty twenty and
Speaker 2: the response from the Fed back then, why don't we
Speaker 2: go ahead and let's just talk about the basis change
Speaker 2: because this was the initial thing that everyone kind of
Speaker 2: reached for when we first started seeing these very extreme
Speaker 2: moves in the bond market, and it's sort of the
Speaker 2: bond market equivalent nowadays of you know how everyone says, oh, somewhere,
Speaker 2: a macro pod is blowing up, right, or a pod shop.
Speaker 2: What did I say, macropod multi strategy is blowing up? Yeah,
Speaker 2: pod is blowing up somewhere. And I feel like people
Speaker 2: start talking about the basis trade as soon as there's
Speaker 2: some fall event in US treasuries nowadays. But what are
Speaker 2: we discovering about the basis trade and its role in
Speaker 2: the sell off a few weeks ago in the aftermath
Speaker 2: and with some new numbers and information that's been coming out.
Speaker 5: Yeah, So firstly that the basis trade, if it was
Speaker 5: the culprit, we didn't see it in the data almost
Speaker 5: immediately because we would have seen things like a reduction
Speaker 5: and open interest of treasury futures. It went down a
Speaker 5: little right, open interest fell slightly, but it wasn't the
Speaker 5: type of magnitude that was outside the normal daily volatility,
Speaker 5: So it didn't seem to be that number two. You
Speaker 5: would have seen the futures move significantly more in magnitude
Speaker 5: against cash if it was the treasury futures basis. I
Speaker 5: think that one of the reasons why many people focused
Speaker 5: on this early on was it was something that the
Speaker 5: Federal Reserve and some other policy makers were worried about
Speaker 5: because they are very highly levered trades. But they have
Speaker 5: to be. But why were these trades created? So these
Speaker 5: trades are created because asset managers, in order to comply
Speaker 5: with some of their own liquidity rules, end up having
Speaker 5: a lot of cash on their balance sheet and to
Speaker 5: make up for their duration gap to be closer to
Speaker 5: the Bloomberg Aggregate Index or whatever their benchmark is, they
Speaker 5: go out and buy futures on top of that cash
Speaker 5: instead of buying an actual treasury security. What that means is,
Speaker 5: because it's a future, there has to be a seller
Speaker 5: for every buyer of a futures contract. So that leaves
Speaker 5: others which has to be then levered investors or dealers
Speaker 5: short treasury futures. Now, if you're short of treasury future
Speaker 5: and you don't want to be short treasury future, you
Speaker 5: don't want to be short treasuries, what do you do?
Speaker 5: You have to hedge that somehow, And there's only realistically
Speaker 5: two ways that people hedge. One is you can buy
Speaker 5: a treasury or you can receive in an interest rate swap,
Speaker 5: and that's what we call an invoice spread. So it's
Speaker 5: futures versus swaps is called an invoice spread. We can
Speaker 5: go back to the history of the nineteen eighties about
Speaker 5: how that got its name, but I think that's unimportant
Speaker 5: for this discussion. So what you did see during that
Speaker 5: period of time was not so much the treasury futures
Speaker 5: basis trade unwinding, but you saw the swap spread portion
Speaker 5: of that trade unwinding. And that's one reason why everyone
Speaker 5: talked about the treasury futures basis, but it really if
Speaker 5: you looked at the price action, it was really the
Speaker 5: swap market that was moving around ten basis points at
Speaker 5: a clip, just on every single headline, every single tweet.
Speaker 5: And I think that that's more reflective of the leverage
Speaker 5: that was being unwound, was more in the over the
Speaker 5: counter swap market as opposed to in the futures. Well,
Speaker 5: I was about say, future's pits is not really pits anymore, but.
Speaker 4: We get it, we get it.
Speaker 2: So just on the swap spreads point, this was basically
Speaker 2: the bank deregulation trade slash duration trade that a lot
Speaker 2: of people put on posts Trump's win in November.
Speaker 5: That's my understanding, correct, Yeah, and we did too. So
Speaker 5: after President Trump won, the expectation was that the enhanced
Speaker 5: supplementary leverage ratio would be removed and that would allow
Speaker 5: banks to own more treasuries. So therefore, if they could
Speaker 5: own more treasuries instead of receiving and interest rate swaps
Speaker 5: to get a little bit more duration to hedge other things,
Speaker 5: they could buy treasuries out right instead. So most people,
Speaker 5: both strategists as well as market participants were putting on
Speaker 5: swapspread wideners. So swapspreads have been negative even when we
Speaker 5: still have libor. So now we use something called SO
Speaker 5: for the secured overnight financing rate, which is basically the
Speaker 5: repurchase agreement market that's used as the underlying for these
Speaker 5: interest rate swaps. It used to be libor. Even when
Speaker 5: it was libor, swap spreads in the long end especially
Speaker 5: were very negative, and the reason for that was the
Speaker 5: new regulations that went into effect again, both dot frank
Speaker 5: and some basle regulations, plus a very underappreciated part of
Speaker 5: the market, which is insurance company regulations, which are often
Speaker 5: regulated by states, not by the federal government. So when
Speaker 5: states said, oh, you have to have a more diversified
Speaker 5: portfolio of credits within your general account for life insurance
Speaker 5: companies or p and C property and casualty insurers we
Speaker 5: call them p and C insurres, they go out and say, okay,
Speaker 5: we want to buy thirty year single a corporate debt. Well,
Speaker 5: if you want to be diversified and be in one
Speaker 5: hundred different names, there's not one hundred names that your
Speaker 5: credit analysts are going to let you be in and
Speaker 5: allow you to buy that issue thirty year debt. So
Speaker 5: what happens is they end up having to buy ten
Speaker 5: year debt or even five year debt in some cases,
Speaker 5: and that leaves these insurance companies with this massive duration
Speaker 5: gap because they have long term liabilities. Right life insurance
Speaker 5: contracts are very long term liabilities. They need to hedge
Speaker 5: that with having their own long term assets on their
Speaker 5: balance sheet, and that ten year corporate doesn't meet that need.
Speaker 5: So how then does an insurance company end up making
Speaker 5: up that duration gap? And the answer is they receive
Speaker 5: an interest rate swaps because it's capital efficient. When you
Speaker 5: start an interest rate swap, your cost is zero as
Speaker 5: opposed to going out and buying a treasury or even
Speaker 5: buying a treasury strip, so as zero coupon long term
Speaker 5: treasury we call them treasury strips. They don't want to
Speaker 5: do that because it's not balance sheet efficient. So that's
Speaker 5: kept swap spreads negative. But what kept swapsharp is even
Speaker 5: more negative, was the fact that banks couldn't own enough
Speaker 5: treasuries in order to kind of hedge their own short
Speaker 5: exposure to interest rate swap. So it's underappreciated how much
Speaker 5: bank and bank balance sheets really matter to the pricing
Speaker 5: of a lot of these trades and security.
Speaker 4: First of all, I just think this is great, and.
Speaker 3: This is really clear as clear as these kind of
Speaker 3: conversations can get.
Speaker 4: This is really helpful.
Speaker 5: You know.
Speaker 4: One of the things when people.
Speaker 3: Hear about these sort of like various trades that are
Speaker 3: basis trade that are going on, they're like, oh, they're
Speaker 3: leveraged sixty to one, and like, oh, they're just gambling.
Speaker 3: And sometimes you hear about all the FED having to like,
Speaker 3: you know, sort of stabilize the system. They're all these
Speaker 3: regular speculators putting on insane leverage for picking up pennies
Speaker 3: and now they're being backstopped. And what I like about
Speaker 3: your explanation or your characterization is they're economic rationales for
Speaker 3: this trade because it often gets flattened into speculation and
Speaker 3: a casino. But various entities, whether it's the banks meeting
Speaker 3: their regulatory obligations, the insurance companies are meeting their regulatory obligations,
Speaker 3: there are real rationales for the existence of these markets
Speaker 3: rooted in economics.
Speaker 2: Well, there's also a utility value, which is why arguably,
Speaker 2: even though regulators are very aware of this you have
Speaker 2: been worried about it, they haven't exactly done anything to
Speaker 2: really like clamp down on it.
Speaker 5: No, totally.
Speaker 3: Like these markets serve economic purpose in a way that
Speaker 3: sometimes I think doesn't come through. Let's go to the
Speaker 3: night that I fell asleep on my couch.
Speaker 2: You know, there's the night that shall forever be known
Speaker 2: as Joe falling asleep on his couch while looking.
Speaker 4: At Bloomberg charts that night.
Speaker 3: So when the market's selling off, when treasuries are selling
Speaker 3: off intensely, you know, I think there's like various interpretations
Speaker 3: or people have different ideas. So that's like, oh, it's
Speaker 3: China getting revenge, or it's a steepener trade. There's going
Speaker 3: to be more inflation in the future, and so the
Speaker 3: path of interest rates is going to be higher than
Speaker 3: we otherwise theod thought. And I'm a sort of strict
Speaker 3: constructionist reader of the yield curve, so I always like that.
Speaker 3: And then there's liquidation. Someone has to meet a margin
Speaker 3: call somewhere, pay cash somewhere, and so they have to
Speaker 3: sell their low liquidity treasuries to get a cash or whatever.
Speaker 4: What was I watching on the couch that night.
Speaker 5: Yeah, so I think there were a few things that
Speaker 5: you were watching. One is you were looking at a
Speaker 5: market that was very liquid. Keep in mind when you
Speaker 5: fell asleep on your couch at midnight East Coast time. Yeah,
Speaker 5: London was not yet open. Okay, so you were talking
Speaker 5: about Tokyo and Hong Kong and Singapore were basically the
Speaker 5: liquidity providers at the time in terms of dealer and
Speaker 5: dealer desks, and they're going to be constrained. So even
Speaker 5: if you only had a little tiny bit of selling
Speaker 5: right in terms of volume, if it was all one
Speaker 5: way at the same time, you probably had dealers that
Speaker 5: weren't willing to take on that exposure at that moment.
Speaker 5: And you'll notice on that day, like if you just
Speaker 5: do an inter date chart and do a GP on
Speaker 5: the tenure yield on the Bloomberg terminal.
Speaker 4: I've done it.
Speaker 5: Yeah, you can see as soon as London opened, the
Speaker 5: market actually came back, and the market actually rallied a bit,
Speaker 5: and there wasn't really any headlines at two am New
Speaker 5: York time. But the fact is you had more liquidity.
Speaker 5: So now you had some bottom fissures. Some people said, oh,
Speaker 5: I can now buy a ten year bond two dollars
Speaker 5: cheaper than I could last night, or when the market
Speaker 5: closed yesterday, so you know, let's just cover a short
Speaker 5: or just maybe take a little bit of a punt
Speaker 5: and a long position. And then the market was still
Speaker 5: very volatile after that. And I think part of the
Speaker 5: reason it continued to be volatile was, besides the fact
Speaker 5: that we had all of the tweets on again off
Speaker 5: again tariff talk, is that people don't like to get
Speaker 5: in front of volatility. And the fact is when volatility
Speaker 5: is high, dealers tend to not only widen their bid offers,
Speaker 5: but they also pull back. And another I think underappreciated
Speaker 5: aspect of this too, and again I go back to
Speaker 5: financial sector balance sheets. If you look at dealers, dealers
Speaker 5: were as long treasuries going into this as they've ever been,
Speaker 5: so they own more treasuries than ever in history. Now
Speaker 5: part of that is because the treasuring market is bigger,
Speaker 5: but a lot of these treasuries that they added they
Speaker 5: added within the last six months. So this wasn't like
Speaker 5: it wasn't like it turned on the dime, and it
Speaker 5: wasn't very systemic. But the fact that there was a
Speaker 5: lot of cash already on dealers balance sheets and still
Speaker 5: is dealers are still very long cash bonds right now,
Speaker 5: and again there are short futures on the other side
Speaker 5: of that, It probably meant that they weren't able to
Speaker 5: take on a lot more supply without getting approvals. Right,
Speaker 5: you have to go to your risk manager and say, hey,
Speaker 5: we'd like to make markets here, but we're fall like
Speaker 5: can we make markets? So there are a certain amount
Speaker 5: of regulatory arbitrage that you can't do today that you
Speaker 5: were able to do prior to the Basle three capital
Speaker 5: rules going into effect. It's what I call balance gad elasticity. Basically,
Speaker 5: dealers don't have the same type of balance sheet elasticity
Speaker 5: as they used to have prior to Basil two and
Speaker 5: a half in Basil three rules.
Speaker 2: Right, So I hate this term. But people are asking
Speaker 2: questions about what real money investors did in all of this,
Speaker 2: and you know, money is money in my book. But
Speaker 2: the idea of you know, I guess people that are
Speaker 2: holding these things on a longer term basis these real
Speaker 2: money investors. And this to me is actually like, this
Speaker 2: is the scenario that could be more worrying than a
Speaker 2: basis trade blow up, because like, okay, basis trades blow up,
Speaker 2: the FED can basically come in and do something pretty
Speaker 2: easily nowadays, and we're talking about a single levered trade
Speaker 2: that's based on arbitraging, like a very technical relationship that's
Speaker 2: blowing out, and so all of those positions are getting
Speaker 2: changed very rapidly. But if we're talking about the collapse
Speaker 2: of a real money investment in US debt because of
Speaker 2: all this policy uncertainty and people wanting to I guess
Speaker 2: dedollarize their balance sheets, that seems much more existential to me.
Speaker 2: So what have you observed in the case of real
Speaker 2: money investors?
Speaker 5: So it depends on how you define real money. So
Speaker 5: I agree with you Tracy there. You know, you're talking
Speaker 5: about central banks, sovereign wealth funds, action managers, you know,
Speaker 5: pension funds and the like, right, so, and they all
Speaker 5: have different economic reasons why they participate in the bond
Speaker 5: market in general and the treasury market in particular. So
Speaker 5: we can go through each of those very briefly. So first,
Speaker 5: you know, it's not obvious to me that central banks
Speaker 5: were selling. So this idea that you know, Joe brought
Speaker 5: up some one of the things that people were saying,
Speaker 5: that oh it's China selling.
Speaker 2: Kind of dumping treasury.
Speaker 5: Yeah, and the fact is is that And I'm not
Speaker 5: going to talk specifically about China, but central banks in
Speaker 5: general when they own treasuries for their reserve account. So
Speaker 5: whether they own treasuries, or they own German boons, or
Speaker 5: they own something in Sterling or Japanese government bonds, they
Speaker 5: own short term securities. They don't go out and buy
Speaker 5: tens and thirties because they don't want to take a
Speaker 5: lot of price risk. They want to be able to
Speaker 5: have their portfolio run off. And you've seen China do
Speaker 5: this actually over the last ten years or so, reduce
Speaker 5: their portfolio in order to defend their currency. And they
Speaker 5: want to be able to do that very quickly without
Speaker 5: moving the market a lot. And in order to do that,
Speaker 5: you own short term debt. Now who does own the
Speaker 5: long term debt? And we put out a chart about
Speaker 5: this actually a couple of weeks ago, actually on the
Speaker 5: eighth and most foreigners who own the long end are
Speaker 5: private investors. So these are portfolio investors. These are pension funds,
Speaker 5: insurance companies, and they own those because they can buy
Speaker 5: treasuries and even after currency hedging, pick up yield compared
Speaker 5: to their own home currency. So one of the perfect
Speaker 5: examples of that is Taiwan. So taiwan Es insurance companies
Speaker 5: will buy a lot of US debt, both corporates and treasuries,
Speaker 5: and if they hedge it back, they still pick up
Speaker 5: yield compared to the Taiwanese dollar debt. So they like
Speaker 5: doing that trade, right, Why wouldn't you You pick up
Speaker 5: yield and you get US treasury risk instead of time
Speaker 5: on treasury risk. If you go to a central bank,
Speaker 5: they won't be doing that, right. They'll go out and
Speaker 5: they'll participate in three year auctions to your auctions. They'll
Speaker 5: buy T bills and let that roll off. So the
Speaker 5: price action that occurred during that period of time April
Speaker 5: seventh to April eleventh didn't react like one would expect.
Speaker 5: If you had central banks who were massive sellers of treasuries,
Speaker 5: you would have expected to see the front end sell off.
Speaker 5: But no, the front end rallied right, So you saw
Speaker 5: lower yields in short term debt and higher yields and
Speaker 5: long term debt. I think part of that was an
Speaker 5: inflation trade. I think that a lot of people thought
Speaker 5: and did think. And I was up late some of
Speaker 5: those nights too, talking with clients in Asia and what
Speaker 5: you heard from many of them is, isn't all of
Speaker 5: this just inflationary? Because what Donald Trump and his administration
Speaker 5: are doing is going to force us into recession or
Speaker 5: he's going to fire Powell. And if he thought does that,
Speaker 5: then interest rates are going to be too low, tariffs
Speaker 5: are going to keep inflation higher. So that all was
Speaker 5: a curve, and that's really the trade that you saw.
Speaker 5: You saw that twist deepening of the yield curve.
Speaker 3: By the way, listeners, especially those who have come new
Speaker 3: to odd Lots, either in recent weeks or recent years,
Speaker 3: should really go back to I think it was twenty nineteen,
Speaker 3: right Tracy with Brad Setzer, one of our legendary episodes
Speaker 3: about Taiwan Life insurers and their voracious appetite for US
Speaker 3: treasuries and the role that the Central Bank of the
Speaker 3: Republic of China, which is Taiwan's central bank plays.
Speaker 2: The closest thing we've ever done to a true crime podcast.
Speaker 4: Yeah exactly. We're not alleging any crime, but it was.
Speaker 5: Misery.
Speaker 3: I had that sense of mystery when anyway, people should
Speaker 3: go back to this one of the all.
Speaker 4: Time great episodes.
Speaker 3: Going back again the night of April eighth, this inflation
Speaker 3: trade idea, I mean, because you mentioned and it was
Speaker 3: very helpful that these were hours of low liquidity. London
Speaker 3: hadn't opened yet, the dealer balance sheets are already priced
Speaker 3: up to the gills, not really inclined to take on
Speaker 3: treasuries in that moment. But it still raises the question
Speaker 3: of the impetus for the selling by the marginal traders
Speaker 3: at the time, why they were selling in the first place,
Speaker 3: as opposed to buying safe haven asset, because that's often
Speaker 3: what you do when the stock market is selling. Is
Speaker 3: it essential? And it sort of sounded like in your
Speaker 3: last answer that it was just a mini version of
Speaker 3: that twenty twenty two dynamic where if you have bad
Speaker 3: growth outcomes and sort of bad inflation outcomes, you sell
Speaker 3: stocks and treasuries at the same time.
Speaker 5: Yeah, if that's if you're looking for a fundamental reason,
Speaker 5: I would say that that would have been the fundamental impetus.
Speaker 5: But I suspect much of it is just positioning. Like, okay,
Speaker 5: I think what is underappreciated. You know, some people say
Speaker 5: that this is just a cop out by you know,
Speaker 5: some strategist who doesn't know what's going on, And I
Speaker 5: can appreciate that a little bit, but positioning does matter.
Speaker 5: So if there were people who were long treasuries in
Speaker 5: Asia at Asia hours, like let's say that it's a
Speaker 5: sovereign wealth fund or an asset manager in Hong Kong
Speaker 5: or Singapore who was long ten year treasuries and thirty
Speaker 5: year treasuries because they thought US was going to have
Speaker 5: a recession and we were going to have lower interest
Speaker 5: rates and all of that. And all of a sudden,
Speaker 5: you hear everything coming out of New York. You wake
Speaker 5: up in the morning and you say, maybe I have
Speaker 5: too much risk on and then you try to take
Speaker 5: off some of that risk in a market that's not
Speaker 5: able to absorb that risk because dealer balance sheets are
Speaker 5: completely anelastic the price then has to move pretty dramatically,
Speaker 5: and you've seen that over different periods of time. Look,
Speaker 5: the Treasury Department right now holds a conference every year
Speaker 5: that I attend very regularly, not every year, but probably
Speaker 5: two out of every three years about resilience of the
Speaker 5: treasury market. And that all stemmed from about ten years ago.
Speaker 5: We had the flash rally where US treasuries rallied fifty
Speaker 5: basis points in fifteen minutes on no news right on nothing.
Speaker 5: So why would that have happened. Well, it's because, well
Speaker 5: the rumor was.
Speaker 2: That it was something happening, right, but no one was
Speaker 2: ever able to prove it correct.
Speaker 5: Yeah, and look I met with the Treasury Department at
Speaker 5: that time. I sat on a dealer and one of
Speaker 5: the what was then one of the major treasury dealers,
Speaker 5: and you know, nobody exactly knew what was going on,
Speaker 5: but there was trading that was going on. It was
Speaker 5: just a very small size. No one was willing to
Speaker 5: take on, you know, basically short the market in a
Speaker 5: very significant way. And this was in some ways just
Speaker 5: the opposite of that. And as the treasury market's gotten bigger,
Speaker 5: keep in mind the treasury market's nearly thirty trillion dollars
Speaker 5: of marketable debt outstanding, of which about twenty three trillion
Speaker 5: dollars is coupon, so not te bills. I always take
Speaker 5: T bills out of this equation, by the way, because
Speaker 5: when people say, oh, there's this wall of debt that
Speaker 5: has to be refinanced this year, the fact is seven
Speaker 5: trillion of that or near seven trillion of that is
Speaker 5: treasury bills.
Speaker 4: That's good to know.
Speaker 5: And with two A seven money market funds having seven
Speaker 5: trillion dollars and only allowed to buy treasuries or do
Speaker 5: treasury repurchase agreements, they're not a rollover risk. So take
Speaker 5: take T bills out of the equation, because the reason
Speaker 5: why Treasury issues all those tea bills is because that's
Speaker 5: where demand is. They would issue less if there was
Speaker 5: less demand. But there is a significant amount of treasuries
Speaker 5: that need to be rolled over every year. Right There's
Speaker 5: you know, half a trillion dollars to a trillion dollars
Speaker 5: every year of coupons that mature need to be rolled
Speaker 5: over just about every quarter. So when you're in a
Speaker 5: situation like that and you're treasury dealer and you have
Speaker 5: to bid at these auctions, you have to save some room,
Speaker 5: and you can't always be full on treasuries, and you
Speaker 5: don't want to get full on treasuries at midnight. If
Speaker 5: you're again like one of the bulch bracket banks and
Speaker 5: the overnight trader in Hong Kong, the last thing you
Speaker 5: want to do is get a tap on your shoulder
Speaker 5: from a risk manager and have that risk manager say
Speaker 5: to you, hey, you broke your budget. You know the
Speaker 5: door's over there. So there's career risk involved in all
Speaker 5: of this as well, which I think is also a
Speaker 5: second thing that's underappreciated is just mentality of trading desks
Speaker 5: is meaningfully different than it was again before Basle, because
Speaker 5: risk managers run the market now, not traders, and I
Speaker 5: think that that's also something else that's underappreciated by a
Speaker 5: lot of people.
Speaker 2: I take the point about career risk and dealer capacity
Speaker 2: for risk being more constrained than it was pre some
Speaker 2: of the Basil rules, but it does strike me just
Speaker 2: getting back to the sort of existential angst when it
Speaker 2: comes to demand for US treasuries. We have seen some
Speaker 2: figures that suggest that we just saw, you know, like
Speaker 2: run of the mill selling of US treasury. So for instance,
Speaker 2: we had Japan's Ministry of Finance showing that private investors
Speaker 2: in the country sold like seventeen point five billion in
Speaker 2: long term bonds in the week this was ended April fourth.
Speaker 2: I actually needed to go and look at what the
Speaker 2: week after happened. But even before then, Japan's private sellers
Speaker 2: they sold a bunch of US bonds, like literally right
Speaker 2: before early November when we had the election, And if
Speaker 2: we look at some of the commentary we've seen from
Speaker 2: analysts over the years, there's a lot of discussion of
Speaker 2: a lack of structural demand for US treasuries, especially overseas. Right, Like,
Speaker 2: some of the foreign buyers that were buying US debt
Speaker 2: a decade or two decades or three decades ago just
Speaker 2: aren't buying as much of it as they used to
Speaker 2: talk to us about. Like the I guess long term
Speaker 2: outlook for US treasury demand, where is that going to
Speaker 2: be coming from? And how true is it that we
Speaker 2: have seen a bit of a rebalancing from foreign to
Speaker 2: domestic sources.
Speaker 5: Well, we certainly have seen a massive shift away from
Speaker 5: Keep in mind about ten years ago, and I can
Speaker 5: get the exact number later, but about ten years ago,
Speaker 5: about half of US debt was owned by foreigners. Now again,
Speaker 5: most of that was it was split out pretty evenly
Speaker 5: between central banks and private investors in terms of the
Speaker 5: risk that they owned. And we talk about risk, not
Speaker 5: necessarily the notional value, because we care about you know,
Speaker 5: who's buying the riskier parts of the market. So ten
Speaker 5: years and thirty year debt, for example, you can buy
Speaker 5: a little bit of that and effectively buy a lot
Speaker 5: of risk the central banks have certainly been diversifying their portfolios,
Speaker 5: and I think that this makes a lot of sense.
Speaker 5: Right if you were a central bank and you said
Speaker 5: fifteen years ago, you said, oh, ninety plus percent of
Speaker 5: our foreign exchange reserves are all in US dollars, but
Speaker 5: we only do fifty percent of our business our trade
Speaker 5: in the US dollar. We do a lot in euros,
Speaker 5: and we do a lot in yen, right, so we
Speaker 5: want to diversify our foreign exchange holdings. That's something that
Speaker 5: has been going on for better part of a decade,
Speaker 5: and in fact, aggregate ownership of US treasuries has actually
Speaker 5: kind of been flatlined, and as a share of the market,
Speaker 5: it's gone way down now. But who's replaced that we
Speaker 5: have to keep it To keep this in mind too,
Speaker 5: and this is to your point, Tracy, I think, is
Speaker 5: like who's going to be the incremental buyer? Because the
Speaker 5: Fed now owns a lot more treasuries than they did, right,
Speaker 5: because they did quantitative ease for the better part of
Speaker 5: three years and they purchased a significant share of the market.
Speaker 5: Now they don't own an unusually high share of the market,
Speaker 5: but in notional terms, it's a very large share. So
Speaker 5: the FED usually owns around twenty percent of the treasury
Speaker 5: market and has basically since the nineteen sixties, Right, It's
Speaker 5: always owned about twenty percent of the market, But now
Speaker 5: the market is so massive, and they were really a
Speaker 5: very large non economic buyer of treasuries that they're hard
Speaker 5: to replace in the market without their being additional. You know,
Speaker 5: I don't love the concept of term premium the way
Speaker 5: that we measure it, but there is term premium right
Speaker 5: in the market, and at some point, term premium has
Speaker 5: to go up if you are not sure where demand
Speaker 5: is going to come from from these longer duration assets,
Speaker 5: and by doing what President Trump's doing, there is a
Speaker 5: fear out there. And I've spoken to a lot of
Speaker 5: investors both here in the US and overseas about is
Speaker 5: there going to be significant demand for treasuries if, say
Speaker 5: to Trump administration's able to get our trade better in
Speaker 5: line the buying of treasuries that you saw back in
Speaker 5: the early two thousands and right after the global financial
Speaker 5: crisis that also coincided with a massive increase to the
Speaker 5: US current account deficit, So we were effectively exporting a
Speaker 5: whole lot of dollars, and as we're exporting those dollars,
Speaker 5: the financial account has to balance, So one of two
Speaker 5: things has to happen. Either people sell the dollar and
Speaker 5: then buy their home currency. Therefore their own currency winds
Speaker 5: up appreciating versus a dollar, and that makes them less competitive,
Speaker 5: and I think that's kind of what President Trump seems
Speaker 5: to want to do at least as one of the
Speaker 5: outcomes of all of this tariff negotiation and trade negotiation.
Speaker 5: Or you have to go out and buy a US
Speaker 5: dollar denominated asset. Now that could be a hard asset,
Speaker 5: it could be corporates, it could be but treasuries are
Speaker 5: the thing that most countries want to own because it's liquid.
Speaker 5: You buy short term treasuries and you kind of know
Speaker 5: you're going to get your money back. You also know
Speaker 5: that you could replace them very easily because there's auctions
Speaker 5: every single month. So there's a whole reason why you
Speaker 5: would want to own treasuries. When the current account bounce
Speaker 5: is massive, go back and just you know, you can
Speaker 5: go on the Bloomberg terminal or go on go on
Speaker 5: to our Bloomberg Intelligence dashboard bi rates and you can
Speaker 5: look at just how much foreigners bought of US debt
Speaker 5: as the current account deficit went up as a current
Speaker 5: account deficit got better. In the second half of the
Speaker 5: twenty teens, you saw that there was significant slowing of
Speaker 5: what foreigners were buying of US dollars because they just
Speaker 5: didn't need to. They had other alternatives and they and
Speaker 5: the current account deficit was significantly lower.
Speaker 4: So I just have one last question.
Speaker 3: I mean, first of all, when it comes to who
Speaker 3: is going to own US treasuries. A. I hear that
Speaker 3: there's a big tax cut plan that's in the works
Speaker 3: in DC, So that's one pocket of people having more
Speaker 3: cash and theoretically marginal buyers. B. You know, you're talking
Speaker 3: about closing the trade deficit. In theory, the only way
Speaker 3: we really closed the trade deficit is with a significant
Speaker 3: fiscal tightening, and so therefore you just have less debt
Speaker 3: to sell. But just on the my last question is,
Speaker 3: you know, Tracy and I are on opposite sides of this,
Speaker 3: the term premium question. I am yet to convinced be
Speaker 3: that it's a useful concept. I like, the old curve
Speaker 3: is the old curve, it's the what.
Speaker 4: It sounds like. You're somewhere in the middle.
Speaker 3: So settle at least the IRA Jersey verdict on how
Speaker 3: we should think about the usefulness or the usefulness of
Speaker 3: measuring this thing called the term premium.
Speaker 5: So the term premium exists. It must exist. But I
Speaker 5: called it the dark matter before some members of the
Speaker 5: Federal Reserve called it the dark matter of the treasury market.
Speaker 5: Term premium has to exist because you have to be
Speaker 5: compensated for risks outside of what the Federal Reserve is
Speaker 5: going to do. And the greater the uncertainty, the greater
Speaker 5: the term premium should be. The farther you go out
Speaker 5: the curve. And that's one of the reasons why the
Speaker 5: yield curve generally is upward sloping. Right, not always, but
Speaker 5: generally it's upward sloping because of the uncertainty about the
Speaker 5: future path of interest rates, and there's you know, there
Speaker 5: is probably a little tiny bit of credit premium in
Speaker 5: that term premium, but really it's a risk premium for
Speaker 5: the unknown going forward. So term premium exists. I think
Speaker 5: I don't love some of the models and the way
Speaker 5: that we actually try to determine term premium. So the
Speaker 5: FED has several different models, like the Adrian Crump model,
Speaker 5: for example, which attempt to quantify what the term premium
Speaker 5: is at any given moment. I like things that you
Speaker 5: can trade, because that's our job. And the problem is
Speaker 5: that if you tried to use the fed's models for
Speaker 5: term premium and said, oh, this looks like it's too
Speaker 5: steep or too flat, and you did those trades, you'd
Speaker 5: lose more than half the time. So they're not particularly
Speaker 5: good predictors of is the market rich or cheap? And
Speaker 5: as investors, that's our job. So they might be interesting
Speaker 5: on an academic basis, but if I can't trade it,
Speaker 5: I don't care about it. And that's why generally speaking,
Speaker 5: I look at the yield curve. I do have my own.
Speaker 5: It's more of a fair value model for the yield
Speaker 5: curve as opposed to a term premium model, but it
Speaker 5: has a similar effect. But you can determine are we
Speaker 5: rich or cheap given the variety of outcomes from both
Speaker 5: the FED reserve and also supply and other inputs that
Speaker 5: we use for those models.
Speaker 2: Joe, you should just admit you were wrong about the
Speaker 2: term premium because we started arguing about this late last
Speaker 2: year early this year when the term premium was going
Speaker 2: up a lot, and you thought it was all about
Speaker 2: Fed expectations, and now now here we are and it's
Speaker 2: still going up.
Speaker 3: I have to admit something that A is completely not
Speaker 3: useful for trading, and B only exists because it theoretically
Speaker 3: has to exist in this world, but we can't observe it.
Speaker 4: Fine, I'll admit it.
Speaker 5: Fine.
Speaker 2: Oh Mike, Okay, Wait, speaking of something else that Joe
Speaker 2: was wrong about. Can we talk about bond market vigilantes
Speaker 2: for a second. So I think there was this expectation
Speaker 2: going into twenty twenty five and the new Trump administration
Speaker 2: that he was going to be all about stock prices,
Speaker 2: and you know, he talked a lot about stock markets
Speaker 2: going up in his first presidency. He kind of suggested
Speaker 2: he wanted stocks to go up in his second presidency,
Speaker 2: and then we saw the big market crash. But you know,
Speaker 2: looking back on it, it kind of feels like bonds
Speaker 2: were the pressure point for him when it comes to
Speaker 2: ratcheting back some of the tariff tenshion. What's the role
Speaker 2: of the bond market, I guess when it comes to
Speaker 2: influencing the new Trump administration.
Speaker 5: I wish we had any real good color about that,
Speaker 5: because that would be very helpful for analyzing what's going
Speaker 5: to come next. I think it matters in many respects.
Speaker 5: In particular, remember they said that, hey, they really want
Speaker 5: to try to get the ten year treasury yield down.
Speaker 5: When Treasury's rallied for the month of February and early March,
Speaker 5: remember President Trump said, oh, look, interest rates are lower. Now,
Speaker 5: that's what we're trying to do. Of course, we've sold
Speaker 5: off since then in March, part because of this risk
Speaker 5: premium that we're talking about, as well as some of
Speaker 5: the structural issues that we discussed earlier in the show.
Speaker 5: I think it matters because, look, the fact is, even
Speaker 5: if the President is able to find half a trillion
Speaker 5: dollars in savings and that sounds so weird to say
Speaker 5: half a tree brillion and still not being big enough
Speaker 5: to kind of matter, you're still going to have trillion
Speaker 5: dollar deficits that need to be funded, not to mention
Speaker 5: rolling over the existing debt that's going to be maturing.
Speaker 5: And as that occurs, you know, you want to get
Speaker 5: the lowest borrowing costs for the taxpayer. So I understand
Speaker 5: that President Trump really would like to see lower tenure yields.
Speaker 5: But one way to do that is to actually issue
Speaker 5: less ten year bonds, right, that's one way, But you
Speaker 5: can't do that unless you really significantly decrease the deficit
Speaker 5: and actually even maybe balance the budget, right, because you're
Speaker 5: going to be issuing more and more. In fact, we're
Speaker 5: coming out with our Treasury Funding report probably right around
Speaker 5: the time that a lot of people listening to this on.
Speaker 5: It'll be on the twenty fifth of April, and next Wednesday,
Speaker 5: the Treasury Department will decide and Scott Bessen and his
Speaker 5: appointees will decide how they're going to fund the deficit.
Speaker 5: And they're still going to be nearly a two trillion
Speaker 5: dollar deficit this year, and he's going to have to
Speaker 5: issue ten year treasuries. So I think that if there's
Speaker 5: not demand from overseas, investors lose faith in the US
Speaker 5: government and its ability to continue to finance the debt.
Speaker 5: That has to worry at any administration, regardless of whether
Speaker 5: it's President Trump or President Biden or whomever.
Speaker 2: All Right, Ira, this is what we call a deliciously
Speaker 2: information data dense episode. So thank you so much for
Speaker 2: coming on. All thoughts, I'm so glad we could finally
Speaker 2: get you on the show, particularly at this exact moment
Speaker 2: in time.
Speaker 3: And thank you so much for taking my side and
Speaker 3: saying I was correct on the term premium. I really
Speaker 3: appreciate you coming on offline lies Lies.
Speaker 5: Absolutely happy to be here.
Speaker 4: That's what I heard, Tracy. Didn't you say I was correct?
Speaker 2: No, you both were wrong. You both said it was
Speaker 2: fed expectations at the time, I was the only one
Speaker 2: who was right. That was a great conversation. And there's
Speaker 2: a lot of technicality in all of this, but like
Speaker 2: part of the story, as Ira was highlighting, is the
Speaker 2: technicalities of like the structure of the US bond market.
Speaker 5: Right.
Speaker 3: This is where we certainly agree, which is that it's
Speaker 3: not always a fudge factor when people talk about technical
Speaker 3: aspects or positioning. I think we both completely agree on this.
Speaker 3: And you can especially that stuff about like just you know,
Speaker 3: the idea of dealers in Asia and why for various
Speaker 3: regulatory reasons and other trade reasons they had all these
Speaker 3: what their balance sheets were. I love that idea that
Speaker 3: like it's the risk managers, not the risk takers, driving
Speaker 3: the market.
Speaker 4: Very useful conversation.
Speaker 5: On that front.
Speaker 2: Yeah, But that said, I mean, I think there are
Speaker 2: still some longer term like changes in structural demand for
Speaker 2: US treasuries. You know, you can go back to reports
Speaker 2: that were published by like it might even have been
Speaker 2: Josh Younger at JP Morgan a few years ago about
Speaker 2: you know, JP Morgan is worried about who's going to
Speaker 2: buy all the US bonds because we have seen that
Speaker 2: structural retreat in receives demand. And if we think about
Speaker 2: what Trump is trying to do right now in terms
Speaker 2: of rebalancing global trade and reducing the US trade deficit,
Speaker 2: it does seem like one of the outcomes of that
Speaker 2: is structurally less demand for US treasury.
Speaker 3: Well, one thing that's really interesting. We're so we're all
Speaker 3: recording this April twenty fourth, and right now the stock
Speaker 3: market is flying today, and actually it's really not that
Speaker 3: far below now. At last I looked, it was only
Speaker 3: three and a half percent below where it was on
Speaker 3: Liberation Day. But we are very close still to the
Speaker 3: bottom of the recent range in the dollar. And so
Speaker 3: one way that that sort of retreat from America trade
Speaker 3: expresses itself, in my mind, is not necessarily through the
Speaker 3: price of the curve or anything, but just the fact
Speaker 3: that like relative to the rest of the world, the
Speaker 3: dollar is less appealing. On one other thing, I just
Speaker 3: want to get in on the question of the treasury
Speaker 3: market's influence on the government. I certainly one hundred percent
Speaker 3: agree with you that the government clearly while it's lower
Speaker 3: and it doesn't like higher yields for all kinds of it.
Speaker 3: They've said it, they've said it's God best and has
Speaker 3: said it. The only reason I don't like the term
Speaker 3: dollar vigilantes is I bon bond vigilantes is that it
Speaker 3: prescribes a level of sort of like agency that I
Speaker 3: don't think is helpful. O.
Speaker 2: Sure, we know, like there was not a single market.
Speaker 3: Why I don't like it as a descriptive frames.
Speaker 2: Look, we're talking about complicated concepts. I think you have
Speaker 2: to have some shorthand here, and I do think, you know, like,
Speaker 2: looking at what happened, it does seem like the administration
Speaker 2: at a minimum, you can say they seem to care
Speaker 2: about rates, which means they care about what bond investors
Speaker 2: are doing. I would like it if there was like
Speaker 2: an actual bond vigilante who you could, like, you know,
Speaker 2: you could flash one of those like Batman signals in
Speaker 2: the sky for the bond vigilante and they would all
Speaker 2: come out and start selling you as treasuries and affect
Speaker 2: change in certain policies that would be interesting anyway, shall
Speaker 2: we leave it there?
Speaker 4: Let's save it there.
Speaker 2: This has been another episode of the aud Loots podcast.
Speaker 2: I'm Tracy Alloway. You can follow me at Tracy Alloway.
Speaker 3: And I'm Joe Wisenthal. You can follow me at the Stalwart.
Speaker 3: Follow Ira Jersey. He's at Ira f Jersey. Follow our
Speaker 3: producers Kerman Rodriguez at Kerman Erman, Dashel Bennett at dashbod
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Speaker 2: Thanks for listening in