Something on the Treasury sell-off last week from RBC’s Michael Cloherty, which we found interesting… it’s another theory about what caused the selling, and whether it’s ‘the big one’ for risk.
We noted earlier that during the sell-off, the yield curve flattened, i.e. the rise in yields on longer-dated bonds was more or less matched at the short end. Whereas you might expect (say) 30-year Treasuries to be particularly sold off, if a fundamental paradigm shift in real rates is suddenly here. So – Cloherty says the selling of short-dated bonds reeks of a carry trade being closed out.
He also adds this about banks’ buying of Treasuries:
The front end moved to levels that are difficult to justify, indicating that this was not a fundamental move. The 2yr moved to 41bps overnight. Banks have $1.6T of reserves at the Fed, and a bank should buy 2yr Treasuries whenever they appear cheap to the expected average interest on excess reserves rate over the next two years. Below we run through three scenarios for the path of interest on excess reserves over the next three years. Note that the prospects for extremely rapid hiking of the Fed funds rate are extremely thin: first, after roughly five years (or more) at 0% there may be strains similar to the strains that appeared when the BOJ tightened in 2000, and second even if inflation is soaring the Fed has the ability to tighten by selling assets (or even talking about selling assets).
So, fakeout at the front end?