The Great Rebalancing
the war on long-end Treasury issuance is just beginning
— The Shadow Cash Market: Part II will follow this more time-sensitive note
After vowing to disrupt the “nothing ever happens” era established by the previous administration, the latest band of U.S. leaders has again reverted to prioritizing the stability of the UST (U.S. Treasury) market over political objectives. The Treasury Sec. has pivoted from slamming predecessors to not only embracing but enhancing the strategy of postponing duration issuance, reducing (some) tension at the long end of the curve. Increased Treasury buybacks, aimed at strengthening the darkest regions of the U.S. sovereign bond market, should arrive momentarily, followed by the case for delaying an increase in coupon (i.e. note and bond) issuance by a few more years, not quarters.
Luckily for the U.S. empire, global finance remains hungry for ultra-short-term U.S. debt. Stablecoin issuers and money funds can’t live without it, while foreign buyers can’t get enough, earning a substantial premium over dollar deposits. The U.S. central bank’s asset portfolio, the SOMA (System Open Market Account), has grown ravenous too. Officials will thus soon need to uphold the Fed’s ample reserve regime, staving off a repeat of the repocalypse by resuming UST purchases1 as early as the end of this year. Despite potentially crowding out supply and disrupting cash-futures basis trades, most Fed alchemists desire to match the duration of the SOMA to the outstanding UST market. Post the conclusion of QT (quantitative tightening), the “Fed’s portfolio managers” are likely set to feast on — and reinvest MBS proceeds2 into — bills.
Alongside its existing OMOs (open market operations), such as o/n (overnight) repos at the SRF, the Fed’s RMOs (reserve management operations) will vacuum up ultra-short-term issuance, initiating both a significant SOMA rebalancing and a quiet demolition of interest rate risk previously absorbed during various crises. Presently, bank reserves continue to deplete via QT, as Fed RRPs — the unwinding of which releases reserves back into the banking system — hover around zero. This is ensuing just as the average maturity in the Fed’s portfolio has increased, setting the stage for Operation Untwist, the near-reverse mechanism of Operation Twist3 that produced a bill drought in the SOMA. A return to a “neutral” Fed portfolio is subsequently looming.