la curva la curva
Unwinding the US Treasury trade
Posted by
Tracy Alloway on Nov 05 13:06. This. Is. Crazy.
That’s the five-year-30-year
swap curve for the US, eurozone, UK and Japan.
The stand-out of course is that steepening US yield curve. And there really is something perverse about the country undertaking the biggest bout of unconventional monetary policy ending up with the steepest curve.
Flattening yield curves are theoretically meant to stimulate the economy by lowering borrowing costs. (For those wondering, steep yield curves also have some benefits — like building banks’ balance sheets back up — more on which later).
Going back to those curves though — this is from Bank of America Merrill Lynch:
The Fed’s QE2 program, which was announced yesterday, should continue to bias the US yield curve steeper. On the other hand, the Euro and UK yield curves are biased flatter because the ECB is on hold with a bias to tighten and the BOE does not seem to be embarking again on QE. We believe that the BoJ will eventually have to ease further as well but the effect should be a flattener.
And the reason for the steepness, in more detail:
The highlight of the Fed’s Treasury purchase program announced yesterday is the concentration of Treasury purchases in the 5y to 10y sector. This purchase program creates, as we’ve highlighted in past publications of the US rates weekly, a negative supply of Treasuries to the private sector in 2011. This will be most acutely felt in the belly of the curve, which is the preferred habitat of foreign institutions. The belly of the curve is also attractive because of favourable carry and roll down due to Fed hikes that are priced into the curve from 2013 onwards. On the other hand, demand for the long end of the curve comes mostly from pension fund flows, which tends to be sporadic. This argues for a steep 5s-30s curve in the US. In addition, the Fed is engaged in fighting disinflation and some pickup in inflation can be welcomed by the Fed … In this scenario, the long end will reflect an addition inflation risk premium, further steepening the US curve.
So $2,500bn worth of QEasing in the States has bought the Fed a
steepening yield curve. Meanwhile, such a steep yield curve works to boost bank profits by upping the amount of money they can make borrowing short and lending long.
This was also one of the reasons why
some commentators believed the Fed should actually be moving to flatten the curve. Suppressing the curve, it was thought, could decrease the attractiveness of the so-called US Treasury ‘curve trade’ and force banks to actually lend to the economy. This particular trade, which involved banks amassing USTs, was
popular for most of 2009 — and was part of analyst Meredith Whitney’s “
great government momentum trade” call back in May last year.
Flattening the yield curve to make banks lend to something other than the US Treasury is predicated on there actually
being some private sector demand for loans (something which is still totally unclear), of course. But it might put a stop to some of the criticism currently being lobbed at the US central bank for its QE2 policy.
The below for example, is Reuters columnist
Felix Salmon’s take on a
4,000-word piece by Shahien Nasiripour about winners and losers in the Fed’s monetary policy:
It’s truly outrageous that banks are lending more money to the U.S. government than they are to all commercial and industrial borrowers combined; well done to Nasiripour for connecting these dots and for providing a much-needed dose of outrage at the way in which Bernanke’s monetary policy simply isn’t helping the broad mass of the U.S. population.
