Hi Ben, appreciate your work, keep it up. As someone who works in the rates market, your description here of the macro reaction in the aftermath of this week’s Fed meeting is a bit inaccurate. The spike in yields on the front end of the curve isn’t explained by the Fed increasing IOER and RRP facility rates by 5bps. The main reason we saw 2-5y yields come up significantly was the hawkish dot plot that projected two median hikes in 2023 (up from zero at the last Fed meeting) followed by James Bullard’s interview with CNBC Friday morning that was even more hawkish, talking about a potential rate hike in 2022. This triggered a rapid unwinding of 2s10s and 5s30s steepener trades from large hedge funds, and that unwind caused a major bear flattener on the yield curve with the short end coming up significantly and 10-30y yields falling. This positioning signals that the rates market is preparing for a tighter monetary environment sooner than previously expected.
It’s true that the RRP facility spiked to an insane $750bn after they adjusted the rate to 5bps, however it was already north of $500bn before the meeting. It’s not true that the Fed exchanges these overnight reserves for short term treasuries and it’s not true that this is what’s affected short end yields. The growth in the RRP facility has been often tweeted about by many lately as a sort of ominous sign of an incoming crash, but it’s not clear that that’s the case. Bank’s reserve ratios are still at zero since covid, so banks aren’t lending to other banks overnight at the effective to balance out reserve requirements, and with the steep recent drawdown of the Treasury General Account putting a lot of downward pressure on overnight and short term yields, it just makes sense for banks to park excess liquidity at the Fed. The surge in RRP certainly is a sign of a massive and potentially dangerous amount of liquidity sloshing around, but we already knew that didn’t we?
Agree with a lot of what you write. And the $750bn figure - should have framed it different.
However, the FED is giving 5bps on treasuries. Typically it buys treasuries, but this is the opposite here. With short-term treasuries paying 5bps, how can the rest of the market sell at zero? This helped lift the front end of the curve as well.
Well they’re still buying the $80bn in treasuries and $40bn in MBS a month. Don’t necessarily agree that the 5bps on the RRP facility is “reverse QE” as that liquidity is not permanently going to be there and will flow back out, while QE is creating new reserves that otherwise wouldn’t have exist. Key distinction. Agree that effective Fed funds and Libor lifted because of the IOER and RRP hike, but I don’t think that’s having as much of an effect even on the 2y yields - feel that mostly bear flattening.
Fed bought at near 0%, offering 0.05% now. They gave the market 5bps. I’m not saying reverse QE. Just saying how can ST Treasury not be impacted by this? Genuinely curious.
The major driver of 2-5y yields is rate hike expectations. Adjusting the IOER and RRP rates was to target effective Fed funds to keep it from dropping closer to zero as the treasury general account draws down (it had gone as low as 5bps). That has been accomplished - its now at 10bps. The curve bear flattening was driven by dot plot and out-of-consensus hawkish comments Bullard made. 2y yields are 10bps higher to 25bps post-Wednesday, 5y yields also about 10bps higher. The IOER adjustment may have had a small effect but hike projections have easily the majority of the impact. IOER/RRP rates are key drivers of like 1M and 3M Libor, effective Fed funds, SOFR, T-bills, etc. Very short end rates not on the yield curve.
Thank you very much for this. Fascinated with Pablo
Hi Ben, appreciate your work, keep it up. As someone who works in the rates market, your description here of the macro reaction in the aftermath of this week’s Fed meeting is a bit inaccurate. The spike in yields on the front end of the curve isn’t explained by the Fed increasing IOER and RRP facility rates by 5bps. The main reason we saw 2-5y yields come up significantly was the hawkish dot plot that projected two median hikes in 2023 (up from zero at the last Fed meeting) followed by James Bullard’s interview with CNBC Friday morning that was even more hawkish, talking about a potential rate hike in 2022. This triggered a rapid unwinding of 2s10s and 5s30s steepener trades from large hedge funds, and that unwind caused a major bear flattener on the yield curve with the short end coming up significantly and 10-30y yields falling. This positioning signals that the rates market is preparing for a tighter monetary environment sooner than previously expected.
It’s true that the RRP facility spiked to an insane $750bn after they adjusted the rate to 5bps, however it was already north of $500bn before the meeting. It’s not true that the Fed exchanges these overnight reserves for short term treasuries and it’s not true that this is what’s affected short end yields. The growth in the RRP facility has been often tweeted about by many lately as a sort of ominous sign of an incoming crash, but it’s not clear that that’s the case. Bank’s reserve ratios are still at zero since covid, so banks aren’t lending to other banks overnight at the effective to balance out reserve requirements, and with the steep recent drawdown of the Treasury General Account putting a lot of downward pressure on overnight and short term yields, it just makes sense for banks to park excess liquidity at the Fed. The surge in RRP certainly is a sign of a massive and potentially dangerous amount of liquidity sloshing around, but we already knew that didn’t we?
Agree with a lot of what you write. And the $750bn figure - should have framed it different.
However, the FED is giving 5bps on treasuries. Typically it buys treasuries, but this is the opposite here. With short-term treasuries paying 5bps, how can the rest of the market sell at zero? This helped lift the front end of the curve as well.
Well they’re still buying the $80bn in treasuries and $40bn in MBS a month. Don’t necessarily agree that the 5bps on the RRP facility is “reverse QE” as that liquidity is not permanently going to be there and will flow back out, while QE is creating new reserves that otherwise wouldn’t have exist. Key distinction. Agree that effective Fed funds and Libor lifted because of the IOER and RRP hike, but I don’t think that’s having as much of an effect even on the 2y yields - feel that mostly bear flattening.
Fed bought at near 0%, offering 0.05% now. They gave the market 5bps. I’m not saying reverse QE. Just saying how can ST Treasury not be impacted by this? Genuinely curious.
The major driver of 2-5y yields is rate hike expectations. Adjusting the IOER and RRP rates was to target effective Fed funds to keep it from dropping closer to zero as the treasury general account draws down (it had gone as low as 5bps). That has been accomplished - its now at 10bps. The curve bear flattening was driven by dot plot and out-of-consensus hawkish comments Bullard made. 2y yields are 10bps higher to 25bps post-Wednesday, 5y yields also about 10bps higher. The IOER adjustment may have had a small effect but hike projections have easily the majority of the impact. IOER/RRP rates are key drivers of like 1M and 3M Libor, effective Fed funds, SOFR, T-bills, etc. Very short end rates not on the yield curve.
Is there a way we, the plebs, can watch Pablo?
Really do appericate your articles with high accuracy! could you let me know how I can join as a private client?