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How Liquid Is the New 20-Year Treasury Bond?

Published by Anonymous (not verified) on Wed, 01/07/2020 - 9:00pm in



Michael Fleming and Francisco Ruela

How Liquid Is the New 20-Year Treasury Bond?

On May 20, the U.S. Department of the Treasury sold a 20-year bond for the first time since 1986. In announcing the reintroduction, Treasury said it would issue the bond in a regular and predictable manner and in benchmark size, thereby creating an additional liquidity point along the Treasury yield curve. But just how liquid is the new bond? In this post, we take a first look at the bond’s behavior, evaluating its trading activity and liquidity using a short sample of data since the bond’s introduction.

Why Was the Bond Reintroduced?

The Treasury has launched a range of new debt products over the years, such as Treasury inflation-protected securities and floating rate notes, and explored the adoption of others, such as an ultra-long 50-year bond. In introducing the 20-year bond, Treasury cited the expected strong demand, which would “increase Treasury’s financing capacity over the long term,” while meeting its objective “to finance the government at the least possible cost to taxpayers over time.” Market participants suggested that the bond could be attractive to liability-driven investors, such as corporate pensions and insurance companies.

Structure Similar to that of Other Notes and Bonds

Like other Treasury coupon securities, 20-year bonds are issued at a price close to par value with a stated rate of interest, pay interest every six months, and are redeemed at par value at maturity. As with the 10-year and 30-year securities, a new 20-year issue is offered each quarter, around the time of the Treasury’s quarterly refunding, with additional amounts offered through scheduled reopenings one and two months later. Coupon and maturity dates are aligned with those of the 10- and 30-year securities, but the bond is auctioned and issued later in the month, to spread auction supply more evenly.

First Issue Meets Strong Demand

The first reintroduced 20-year bond was announced for auction on May 14 with a May 20 auction date, June 1 issuance date, and maturity date of May 15, 2040. The issue faced strong demand at auction, with a high yield (corresponding to the lowest accepted bid price) of 1.22 percent, close to the rate in the when-issued market right before the auction close. The 1.22 percent yield led to a coupon rate of 11/8 percent (coupon rates are set in 1/8 percent increments at the highest increment less than or equal to the high yield). Over $50 billion in bids were submitted for the $20 billion offered, resulting in a bid-to-cover ratio of over 2.5.

The bidder category and investor class allotment data, described in this article, suggest similar buyers at auction as for the 10- and 30-year securities. Primary dealers, which are expected to backstop Treasury auctions, bid for roughly $28 billion of the issue and were awarded just under $5 billion, or 25 percent of the amount offered. Investment funds bought 58 percent of the issue, foreign and international investors 13 percent, other dealers and brokers 4 percent, and all other investors 1 percent (including depository institutions, pension and retirement funds, insurance companies, and individuals).

How We Evaluate the New Bond’s Functioning

We analyze the initial performance of the 20-year bond using a short sample of data from the BrokerTec electronic trading platform. As described in this post, roughly half of Treasury securities trading occurs through interdealer brokers (IDBs), in which dealers and other professional traders transact with one another, and roughly half between dealers and customers. In the IDB market, electronic platforms accounts for about 87 percent of IDB trading, and BrokerTec is estimated to account for 80 percent of electronic IDB trading. As described here, all Treasury security trading through electronic IDBs is in the most recently auctioned (or on-the-run) coupon-bearing securities, so our data for the 20-year bond starts May 21 (the day following the first auction).

Price Behavior Tracks 10- and 30-Year Securities

Not surprisingly, the 20-year yield has traded between that of the 10-year note and 30-year bond, with closing yields on May 29 of 0.66 percent (10-year), 1.18 percent (20-year), and 1.41 percent (30-year). Moreover, the 20-year yield traded in lockstep with the 10- and 30-year securities over our short sample, as shown in the chart below. The correlations of 30-minute yield changes during New York trading hours (7:30 a.m. to 5 p.m.) between the 20-year bond and those of the 10-year note and 30-year bond have been 94 percent and 97 percent, respectively.

How Liquid Is the New 20-Year Treasury Bond?

Trading Activity Is Modest

Trading activity of the new bond is much less than that of other recently issued Treasury securities, averaging $2.4 billion per day on the BrokerTec platform over the issue’s short life. Trading frequency—about 2,000 trades per day—is similarly lower than that for other securities. The lower activity may reflect the newness of the security and activity might be expected to increase in the future, as discussed below. Average trade size of $1.2 million is similar to that of the 30-year bond, and just above BrokerTec’s minimum trade size of $1 million. More generally, trade size tends to decrease with the tenor, and hence price sensitivity to rate changes, of the security.

How Liquid Is the New 20-Year Treasury Bond?

Market Liquidity Similar to that of 30-Year Bond

The liquidity of the 20-year bond appears similar to that of the 30-year. Average bid-ask spreads are slightly wider, at 1.2 32nds of a point, vs. 1.0 32nds for the 30-year, with some market makers expressing surprise at the tightness of the 20-year spreads given the security’s newness. Order book depth is appreciably lower, averaging just $11 million at the best five price tiers (averaged across the bid and offer sides), vs. $19 million for the 30-year. Price impact, in contrast, is slightly lower at 4.8 32nds per $100 million vs. 5.5 32nds for the 30-year. More generally, liquidity tends to worsen with the tenor, and hence price sensitivity to rate changes, of the security.

How Liquid Is the New 20-Year Treasury Bond?

Liquidity Continued to Improve in May

The new 20-year bond was introduced shortly after the historically high level of illiquidity in March 2020, which accompanied increased concerns about the COVID-19 pandemic and its effects on the economy. Market liquidity improved in late March and April, as discussed in this post, and continued to improve in May. The next chart thus shows 10- and 30-year security bid-ask spreads continuing to narrow in May to levels comparable to those of February. Other liquidity measures (not shown) point to improved order book depth and a lower price impact of trades in May for both the 10- and 30-year securities.

How Liquid Is the New 20-Year Treasury Bond?


Our finding that the 20-year bond is less active than other recently issued Treasuries, and of similar liquidity to the 30-year bond, is based on data from the electronic interdealer broker segment of the market. While this segment is generally representative of the broader market, there may be differences across segments we don’t observe. Moreover, there are reasons to think the bond might be more liquid and actively traded in the future. Several large market makers have noted that they are waiting to see how trading and liquidity conditions evolve before starting to trade the security. In addition, the 20-year bond will be reopened twice after its initial issuance, increasing the issue’s size, and larger issues are more liquid. Lastly, as time passes, the supply in the 20-year sector more generally will increase, improving opportunities for relative-value trading, thereby fostering liquidity.

Looking Forward

The government’s borrowing needs have increased sharply as a result of the COVID-19 outbreak, with the Treasury Department stating, for example, that it was expecting to borrow nearly $3 trillion, on net, in the April to June quarter alone. Reintroduction of the 20-year bond is thus just one debt management change among many this year. Treasury is also increasing auction sizes across coupon securities, as it shifts its financing from bills to longer-dated tenors over the coming quarters. Moreover, the possibility of issuing a floating rate note indexed to the Secured Overnight Financing Rate continues. The implications for market liquidity as Treasury issuance evolves will be an ongoing area of interest.

Michael J. Fleming
Michael J. Fleming is a vice president in the Federal Reserve Bank of New York’s Research and Statistics Group.

Francisco RuelaFrancisco Ruela is a senior research analyst in the Bank’s Research and Statistics Group.

How to cite this post:

Michael Fleming and Francisco Ruela, “How Liquid Is the New 20-Year Treasury Bond?,” Federal Reserve Bank of New York Liberty Street Economics, July 1, 2020,


The views expressed in this post are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.

Do You Know Steve Mnuchin’s Deputy Justin Muzinich?

Published by Anonymous (not verified) on Wed, 03/06/2020 - 4:32am in

Deputy Treasury Secretary Justin Muzinich has an increasingly prominent role. He still has ties to his family’s investment firm, which is a major beneficiary of the Treasury’s bailout actions. Federal Reserve Chairman Jerome Powell and Treasury Secretary Steven Mnuchin have become the public faces of the $3 trillion federal coronavirus bailout. Behind the scenes, however, the Treasury’s responsibilities have fallen largely to the 42-year-old deputy secretary, Justin Muzinich Continue reading

The post Do You Know Steve Mnuchin’s Deputy Justin Muzinich? appeared first on

In a World Where Banks Do Not Aspire to be Intermediaries, Is It Time to Cut Out the Middlemen? (Part I)

Published by Anonymous (not verified) on Thu, 16/04/2020 - 11:00pm in

“Bankers have an image problem.”

Marcy Stigum

By Elham Saeidinezhad | Despite the extraordinary quick and far-reaching responses by the Fed and US Treasury, to save the economy following the crisis, the market sentiment is that “Money isn’t flowing yet.” Banks, considered as intermediaries between the government and troubled firms, have been told to use the liberated funds to boost financing for individuals and businesses in need. However, large banks are reluctant, and to a lesser extent unable, to make new loans even though regulators have relaxed capital rules imposed in the wake of the last crisis. This paradox highlights a reality that has already been emphasized by Mehrling and Stigum but erred in the economic orthodoxy.

To understand this reluctance by the banks, we must preface with a careful
look at banking. In the modern financial system, banks are “dealers” or “market
makers” in the money market rather than intermediaries between deficit and
surplus agents. In many markets such as the UK and US, these government support
programs are built based on the belief that banks are both willing and able to
switch to their traditional role of being financial intermediaries seamlessly.
This intermediation function enables banks to become instruments of state aid,
distributing free or cheap lending to businesses that need it, underpinned by
government guarantees.  This piece (Part l) uses the Money View and a
historical lens to explain why banks are not inspired anymore to be financial
intermediaries. In Part ll, we are going to propose a possible resolution to
this perplexity. In a financial structure where banks are not willing to be
financial intermediaries, central banks might have to seriously entertain the
idea of using central bank digital currency (CBDC) during a crisis. Such tools
enable central banks to circumvent the banking system and inject liquidity
directly to those who need it the most.

Stigum once observed that bankers have, at times, an image problem. They are
seen as the culprits behind the high-interest rates that borrowers must pay and
as acting in ways that could put the financial system and the economy at risk, perhaps
by lending to risky borrowers, when interest rates are low. Both charges
reflect the constant evolution in banks’ business models that lead to a few
severe misconceptions over the years. The first delusion is about the
banks’ primary function. Despite the common belief, banks are not
intermediaries between surplus and deficit agents anymore. In this new system,
banks’ primary role is to act as dealers in money market securities, in
governments, in municipal securities, and various derivative products. Further,
several large banks have extensive operations for clearing
money market trades for nonbank dealers. A final important activity for money
center banks is foreign operations of two sorts: participating
in the broad international capital market known as the Euromarket and operating
within the confines of foreign capital markets (accepting deposits and making
loans denominated in local currencies). 

Structural changes that have taken place on corporates’ capital structure
and the emergence of market-based finance have led to this reconstruction in
the banking system. To begin with, the corporate treasurers switched sources
of corporate financing for many corporates from a bank loan to money
market instruments such as commercial papers. In the late 1970s and early
1980s, when rates were high, and quality-yield spreads were consequently wide,
firms needing working capital began to use the sale of open market commercial
paper as a substitute for bank loans. Once firms that had previously borrowed
at banks short term were introduced to the paper market, they found that most
of the time, it paid them to borrow there. This was the case since money
obtained in the credit market was cheaper than bank loans except when the
short-term interest rate was being held by political pressure, or due to a
crisis, at an artificially low level.

The other significant change in market structure was the rise of “money
market mutual funds.” These funds provide more lucrative investment
opportunities for depositors, especially for institutional investors, compared
to what bank deposits tend to offer. This loss of large deposits led bank
holding companies to also borrow in the commercial paper market to fund bank
operations. The death of the deposits and the commercial loans made the
traditional lending business for the banks less attractive. The lower returns
caused the advent of the securitization market and the “pooling” of
assets, such as mortgages and other consumer loans. Banks gradually shifted
their business model from a traditional “original and hold” to an
“originate-to-distribute” in which banks and other lenders could
originate loans and quickly sell them into securitization pools. The goal was
to increase the return of making new loans, such as mortgages, to their clients
and became the originators of securitized assets.

The critical aspect of these developments is that they are mainly
off-balance sheet profit centers. In August 1970, the Fed ruled that funds
channeled to a member bank that was raised through the sale of commercial paper
by the bank’s holding company or any of its affiliates or subsidiaries were
subject to a reserve requirement. This ruling eliminated the sale of bank
holding company paper for such purposes. Today, bank holding companies, which
are active issuers of commercial paper, use the money obtained from the sale of
such paper to fund off-balance sheet, nonbank, activities. Off-balance sheet
operations do not require substantial funding from the bank when the contracts
are initiated, while traditional activities such as lending must be fully
funded. Further, most of the financing of traditional activities happens
through a stable base of money, such as bank capital and deposits. Yet,
borrowing is the primary source of funding off-balance sheet activities.

To be relevant in the new market-based credit system, and compensate for the
loss of their traditional business lines, the banks started to change their
main role from being financial intermediaries to becoming dealers in money
market instruments and originators of securitized assets. In doing so, instead
of making commercial loans, they provide liquidity backup facilities on
commercial paper issuance. Also, to enhance the profitability of making
consumer loans, such as mortgages, banks have turned to securitization
business and have became the originators of securitized loans. 

In the aftermath of the COVID-19 outbreak, the Fed, along with US Treasury,
has provided numerous liquidity facilities to help illiquid small and medium
enterprises. These programs are designed to channel funds to every corner of
the economy through banks. For such a rescue package to become successful,
these banks have to resume their traditional financial intermediary role to
transfer funds from the government (the surplus agents) to SMEs (the deficit
agents) who need cash for payroll financing. Regulators, in return, allow banks
to enjoy lower capital requirements and looser risk-management standards. On
the surface, this sounds like a deal made in heaven.

In reality, however, even though banks have received regulatory leniency,
and extra funds, for their critical role as intermediaries in this rescue
package, they give the government the cold shoulder. Banks are very reluctant
to extend new credits and approve new loans. It is easy to portray banks as
villains. However, a more productive task would be to understand the underlying
reasons behind banks’ unwillingness. The problem is that despite what the Fed
and the Treasury seem to assume, banks are no longer in the business of
providing “direct” liquidity to financial and non-financial institutions. The
era of engaging in traditional banking operations, such as accepting deposits
and lending, has ended. Instead, they provide indirect finance through their
role as money market dealers and originators of securitized assets.

In this dealer-centric, wholesale, world, banks are nobody’s agents but
profits’. Being a dealer and earning a spread as a dealer is a much more
profitable business. More importantly, even though banks might not face
regulatory scrutiny if these loans end up being nonperforming, making such
loans will take their balance sheet space, which is already a scarce commodity
for these banks. Such factors imply that in this brave new world, the
opportunity cost of being the agent of good is high. Banks would have to give
up on some of their lucrative dealing businesses as such operation requires
balance sheet space. This is the reason why financial atheists have already
started to warn that banks should not be shamed into a do-gooder
lending binge

Large banks rejected the notion that they should use their freed-up equity
capital as a basis for higher leverage, borrowing $5tn of funds to spray at the
economy and keep the flames of coronavirus at bay. Stigum once said that
bankers have an image problem. Having an image problem does not seem to be one
of the banks’ issues anymore. The COVID-19 crisis made it very clear that banks
are very comfortable with their lucrative roles as dealers in the money market
and originators of assets in the capital market and have no intention to be
do-gooders as financial intermediaries. These developments could suggest that
it is time to cut out banks as middlemen. To this end, central bank digital
currency (CBDC) could be a potential solution as it allows central banks to
bypass banks to inject liquidity into the system during a period of heightened
financial distress such as the COVID-19 crisis.

Elham Saeidinezhad is lecturer in Economics at UCLA. Before joining the Economics Department at UCLA, she was a research economist in International Finance and Macroeconomics research group at Milken Institute, Santa Monica, where she investigated the post-crisis structural changes in the capital market as a result of macroprudential regulations. Before that, she was a postdoctoral fellow at INET, working closely with Prof. Perry Mehrling and studying his “Money View”.  Elham obtained her Ph.D. from the University of Sheffield, UK, in empirical Macroeconomics in 2013. You may contact Elham via the Young Scholars Directory

The post In a World Where Banks Do Not Aspire to be Intermediaries, Is It Time to Cut Out the Middlemen? (Part I) appeared first on Economic Questions .

Should the Fed Add FX Swaps to its Asset Purchasing Programs?

Published by Anonymous (not verified) on Fri, 10/04/2020 - 3:41am in


Fed, money, Treasury

By Elham Saeidinezhad and Jack Krupinski

“As Stigum reminded us, the market for Eurodollar deposits follows the sun around the globe. Therefore, no one, including and especially the Fed, can hide from its rays.”

The COVID-19 crisis renewed the heated debate on whether the US dollar
could lose its status as the world’s dominant currency. Still, in
present conditions, without loss of generality, the world reserve currency is
the dollar. The exorbitant privilege implies that the deficit
agents globally need to acquire dollars. These players probably have a small
reserve holding, usually in the form of US Treasury securities. Still, more
generally, they will need to purchase dollars in a global foreign exchange (FX)
markets to finance their dollar-denominated assets. One of the significant
determinants of the dollar funding costs that these investors face is
the cost of hedging foreign exchange risk. Traditionally, the market for the
Eurodollar deposits has been the final destination for these non-US investors.
However, after the great financial crisis, investors have turned to a
particular, and important segment of the FX market, called the FX swap
, to raise dollar funding. This shift in the behavior of foreign
investors might have repercussions for the rates in the US money market.

The point to emphasize is that the price of Eurodollar funding, used to
discipline the behavior of the foreign deficit agents, can affect the US
domestic money market. This usage of FX swap markets by foreign investors to
overcome US dollar funding shortages could move short-term domestic rates from
the Fed’s target range. Higher rates could impair liquidity in US money markets
by increasing the financing cost for US investors. To maintain the FX swap rate
at a desirable level, and keep the Fed Funds rate at a target range, the Fed
might have to include FX derivatives in its asset purchasing programs.

The use of the FX swap market to raise dollar funding depends on the
relative costs in the FX swap and the Eurodollar market. This relative cost is
represented in the spread between the FX swap rate and LIBOR. The “FX
swap-implied rate” or “FX swap rate” is the cost of raising foreign currency
via the FX derivatives market. While the “FX swap rate” is the primary
indicator that measures the cost of borrowing in the FX swap market, the
“FX-hedged yield curve” represents that. The “FX-hedged yield curve” adjusts
the yield curve to reflect the cost of financing for hedged international
investors and represents the hedged return. On the other hand, LIBOR, or
probably SOFR in the post-LIBOR era, is the cost of raising dollar directly
from the market for Eurodollar deposits.

In tranquil times, arbitrage, and the corresponding Covered Interest Parity
condition, implies that investors are indifferent in tapping either market to
raise funding. On the contrary, during periods when the bank balance sheet
capacity is scarce, the demand of investors shifts strongly toward a
particular market as the spread between LIBOR and FX swap rate increases
sharply. More specifically, when the FX swap rate for a given currency is less
than the cost of raising dollar directly from the market for Eurodollar
deposits, institutions will tend to borrow from the FX swap market rather than
using the money market. Likewise, a higher FX swap rate would discourage the
use of FX swaps in financing.

By focusing on the dollar funding, it is evident that the FX swap market is
fundamentally a money market, not a capital market, for at least two reasons.
First, the overwhelming majority of the market is short-term. Second, it
determines the cost of Eurodollar funding, both directly and indirectly,
by providing an alternative route of funding. It is no accident that since the
of the COVID-19 outbreak, indicators of dollar funding
costs in foreign exchange markets, including “FX swap-implied rate”, have risen
sharply, approaching levels last seen during the great financial crisis. During
crises, non-US banks usually finance their US dollar assets by tapping the FX
swap market, where someone borrows dollars using FX derivatives by pledging
another currency as collateral. In this period, heightened uncertainty leads US
banks that face liquidity shortage to hoard liquid assets rather than lend to
foreigners. Such coordinated decisions by the US banks put upward pressure on
FX swap rates.

The FX swap market also affects the cost of Eurodollar funding indirectly
through the FX dealers. In essence, most deficit agents might acquire
dollars by relying entirely on the private FX dealing system. Two different
types of dealers in the FX market are typical FX dealers and speculative
dealers. The FX dealer system expedites settlement by expanding credit.
In the current international order, the FX dealer usually has to provide dollar
funding. The dealer creates a dollar liability that the deficit agent
buys at the spot exchange rate using local currency, to pay the
surplus country. The result is the expansion of the dealer’s balance sheet and
its exposure to FX risk. The FX risk, or exchange risk, is a risk that the
dollar price of the dealer’s new FX asset might fall. The bid-ask spread that
the FX dealer earns reflects this price risk and the resulting cost of hedging.

As a hedge against this price risk, the dealer enters an FX swap market to
purchase an offsetting forward exchange contract from a speculative dealer. As
Stigum shows, and Mehrling emphasizes, the FX dealer borrows term FX
currencies and lends term dollars. As a result of entering into a forward
contract, the FX dealer has a “matched book”—if the dollar price of its new FX
spot asset falls, then so also will the dollar value of its new FX term
liability. It does, however, still face liquidity risk since maintaining the
hedge requires rolling over its spot dollar liability position until the
maturity of its term dollar asset position. A “speculative” dealer provides the
forward hedge to the FX dealer. This dealer faces exposure to exchange risk and
might use a futures position, or an FX options position to hedge. The point to
emphasize here is that the hedging cost of the speculative dealer affects the
price that the normal FX dealer faces when entering a forward contract and
ultimately determines the price of Eurodollar funding. 

The critical question is, what connects the domestic US markets with the
Euromarkets as mentioned earlier? In different maturity ranges, US and
Eurodollar rates track each other extraordinarily closely over time. In other
words, even though spreads widen and narrow, and sometimes rates cross, the
main trends up and down are always the same in both markets. Stigum (2007) suggests
that there is no doubt that this consistency in rates is the work of

Two sorts of arbitrages are used to link US and Eurodollar rates,
technical and transitory. Opportunities for technical arbitrage
vanished with the movement of CHIPS to same-day settlement and payment
finality. Transitory arbitrages, in contrast, are money flows that occur in
response to temporary discrepancies that arise between US and
Eurodollar rates because rates in the two markets are being affected
by differing supply and demand pressures. Much transitory arbitrage used
to be carried on by banks that actively borrow and lend funds in both markets.
The arbitrage that banks do between the domestic and Eurodollar markets is
referred to as soft arbitrage. In making funding choices,
domestic versus Eurodollars, US banks always compare relative costs on an
all-in basis.

But that still leaves open the question of where the primary impetus for
rate changes typically comes from. Put it differently, are changes in US rates
pushing Eurodollar rates up and down, or vice versa? A British Eurobanker has a
brief answer: “Rarely does the tail wag the dog. The US money market is the
dog, the Eurodollar market, the tail.” The statement has been a truth for most
parts before the great financial crisis. The fact of this statement has created
a foreign contingent of Fed watchers. However, the direction of this effect
might have reversed after the great financial crisis.  In other words,
some longer-term shifts have made the US money market respond to the
developments in the Eurodollar funding.

This was one of the lessons from the US repo-market turmoil. On Monday,
September 16, and Tuesday, September 17, Overnight Treasury general collateral
(GC) repurchase-agreement (repo) rates surprisingly surged to almost 10%. Two
factors made these developments extraordinary: First, the banks, who act as a
dealer of near last resort in this market due to their direct access to the
Fed’s balance sheets, did not inject liquidity. Second, this time around, the
Secured Overnight Financing Rate (SOFR), which is replacing LIBOR to measure
the cost of Eurodollar financing, also increased significantly, leading the Fed
to intervene directly in the repo market.

Credit Suisse’ Zoltan Poszar points out that an increase in the supply of US
Treasuries along with the inversion in the FX-hedged yield of Treasuries
has created such anomalies in the US money market.  Earlier last
year, an increase in hedging costs caused the inversion of a curve
that represents the FX-hedged yield of Treasuries at different maturities.
Post- great financial crisis, the size of foreign demands for US assets,
including the US Treasury bonds, increased significantly. For these investors,
the cost of FX swaps is the primary factor that affects their demand for US
assets since that hedge return, called FX-hedged yield, is an important
component of total return on investment. This FX-hedged yield ultimately drives
investment decisions as hedge introduces an extra cash flow that a domestic
bond investment does not have. This additional hedge return affects liquidity
considerations because hedging generates its own cash flows.

The yield-curve inversion disincentivizes foreign investors, mostly carry
traders, trying to earn a margin from borrowing short term to buy Treasuries
(i.e., lending longer-term). Demand for Eurodollars—which are required by
deficit agents to settle payment obligations—is very high right now, which has
caused the FX Swap rate-LIBOR spread to widen. The demand to directly raise
dollars through FX swaps has driven the price increase, but this also affects
investors who typically use FX swaps to hedge dollar
. As the hedge return falls (it is negative for the Euro), it
becomes less profitable for foreign investors to buy Treasury debt. More
importantly, for foreign investors, the point at which this trade becomes
unprofitable has been reached way before the yield curve inverted, as they had
to pay for hedging costs (in yen or euro). This then forces Treasuries onto the
balance sheets of primary dealers and have repercussions in the domestic money
market as it creates balance sheet constraints for these large banks. This
constraint led banks with ample reserves to be unwilling to lend money to each
other for an interest rate of up to 10% when they would only receive 1.8% from
the Fed.

This seems like some type of “crowding out,” in which demand for
dollar funding via the FX swap has driven up the price of the derivative
and crowded out those investors who would typically use the swap as a hedging
tool. Because it is more costly to hedge dollar investments, there is a risk
that demand for US Treasuries will decrease. This problem is driven by the
“dual-purpose” of the FX swaps. By directly buying this derivative, the Fed can
stabilize prices and encourage foreign investors to keep buying Treasuries by
increasing hedge return. Beyond acting to stabilize the global financial
market, the Fed has a direct domestic interest in intervening in the FX market
because of the spillover into US money markets.

The yield curve that the Fed should start to influence is the FX-hedged
yield of Treasuries, rather than the Treasury yield curve since it encompasses
the costs of US dollar funding for foreigners. Because of the spillover of FX
swap turbulences to the US money markets, the FX swap rate will influence the
US domestic money market. If we’re right about funding stresses and the
direction of effects, the Fed might have to start adding FX swaps to its asset
purchasing program. This decision could bridge the imbalance in the FX swap
market and offer foreign investors a better yield. The safe asset – US
Treasuries – is significantly funded by foreign investors, and if the FX swap
market pulls balance sheet and funding away from them, the safe asset will go
on sale. Treasury yields can spike, and the Fed will have to shift from buying
bills to buying what matters– FX derivatives. Such ideas might make some
people- especially those who believe that keeping the dollar as the world’s
reserve currency is a massive drag on the struggling US economy and label the
dollar’s international status as an “an exorbitant burden,”- uncomfortable.
However, as Stigum reminded us, the market for Eurodollar deposits follows the
sun around the globe. Therefore, no one, including and especially the Fed, can
hide from its rays.

Elham Saeidinezhad is lecturer in Economics at UCLA. Before joining the Economics Department at UCLA, she was a research economist in International Finance and Macroeconomics research group at Milken Institute, Santa Monica, where she investigated the post-crisis structural changes in the capital market as a result of macroprudential regulations. Before that, she was a postdoctoral fellow at INET, working closely with Prof. Perry Mehrling and studying his “Money View”.  Elham obtained her Ph.D. from the University of Sheffield, UK, in empirical Macroeconomics in 2013. You may contact Elham via the Young Scholars Directory

Jack Krupinski is a student at UCLA, studying Mathematics and Economics. He is pursuing an actuarial associateship and is working to develop a statistical understanding of risk. Jack’s economic research interests involve using the “Money View” and empirical methods to analyze international finance and monetary policy.

The post Should the Fed Add FX Swaps to its Asset Purchasing Programs? appeared first on Economic Questions .

How the Fed Managed the Treasury Yield Curve in the 1940s

Published by Anonymous (not verified) on Mon, 06/04/2020 - 9:00pm in

Kenneth D. Garbade

The coronavirus pandemic has prompted the Federal Reserve to pledge to purchase Treasury securities and agency mortgage-backed securities in the amount needed to support the smooth market functioning and effective transmission of monetary policy to the economy. But some market participants have questioned whether something more might not be required, including possibly some form of direct yield curve control. In the first half of the 1940s the Federal Open Market Committee (FOMC) sought to manage the level and shape of the Treasury yield curve. In this post, we examine what can be learned from the FOMC’s efforts of seventy-five years ago.

Lessons in Yield Management

The FOMC’s efforts offer two lessons in yield curve management:

1. The shape of the yield curve cannot be fixed independently of the volatility of interest rates and debt management policies.

During World War II the FOMC sought to maintain a fixed, positively sloped curve. The policy left long-term bonds with the risk characteristics of short-term debt but a yield more than 200 basis points higher. At the same time, the Treasury pursued a policy of issuing across the curve, from 13-week bills to 25-year bonds. Faced with investor preferences for the higher yielding, but hardly riskier, bonds, the System Open Market Account had to absorb a substantial quantity of bills. A flatter curve and/or a less rigid interest rate policy might have required less aggressive interventions.

2. Large-scale open market operations may be required in the course of refixing, from time to time, the shape of the yield curve.

After 1946, Federal Reserve officials pursued a program of gradual relaxation of the wartime regime, beginning with the elimination of the fixed rate for 13-week bills, continuing with incremental increases in the ceiling rate on 1-year securities, and then moving further out the curve, with the ultimate goal of a free market for all Treasury debt. Following the elimination of the fixed bill rate in 1947, investors began to move their portfolios into shorter-term debt. The result was a massive shift in the composition of the Open Market Account as the Account bought bonds and sold bills to accommodate the changing maturity preferences of private investors.

The Coming of War

World War II began on Friday, September 1, 1939. By mid-1940, Germany had defeated Poland, France, and Belgium, and a British expeditionary force had been forced to withdraw from the continent. In a speech on October 30, President Roosevelt promised Britain “every assistance short of war” and Britain soon began placing orders for large quantities of planes, artillery, tanks, and other heavy weapons, even though it lacked the financial resources to pay. Congress signaled that it would finance whatever Britain required when it passed the Lend-Lease Act in March 1941.

Emanuel Goldenweiser, director of the Division of Research and Statistics at the Federal Reserve Board, recommended to the FOMC in June 1941 that “a definite rate be established for long-term Treasury offerings, with the understanding that it is the policy of the Government not to advance this rate during the emergency.” He suggested 2½ percent and argued that “when the public is assured that the rate will not rise, prospective investors will realize that there is nothing to gain by waiting, and a flow into Government securities of funds that have been and will become available for investment may be confidently expected.” Three months later, Goldenweiser recommended a congruent monetary policy, “a policy under which a pattern of interest rates would be agreed upon from time to time and the System would be pledged to support that pattern for a definite period.”

Financing American Participation in World War II

Active U.S. participation in World War II followed the bombing of Pearl Harbor in December 1941 and ended with the surrender of Germany in April 1945 and Japan four months later. From year-end 1941 to year-end 1945, Treasury indebtedness increased from $58 billion to $276 billion. Marketable debt accounted for 72 percent of the increase; war savings bonds and special issues to government trust funds accounted for the balance. The increase in marketable debt included $15 billion of bills, $38 billion of short-term certificates, $17 billion of notes, and $87 billion of conventional bonds.

By mid-1942 the Treasury yield curve was fixed for the duration of the war, anchored at the front end with a ⅜ percent bill rate and at the long end with a 2½ percent long-bond rate. Intermediate yields included ⅞ percent on 1-year issues, 2 percent on 10-year issues, and 2¼ percent on 16-year issues.

Experience with the Fixed Pattern of Rates

Fixing the level of Treasury yields endogenized the size of the System Open Market Account: the Fed had to buy whatever private investors did not want to hold at the fixed rates. As a result, the size of the Account increased from $2.25 billion at the end of 1941 to $24.26 billion at the end of 1945.

Fixing the pattern of Treasury yields endogenized the maturity distribution of publicly held debt. In each market sector, the Fed had to buy whatever private investors did not want to hold and, up to the limits of its holdings, had to sell whatever private investors wanted to buy beyond what the Treasury was issuing.

Investors quickly came to appreciate that they faced a positively sloped yield curve in a market where yields were at or near their ceiling levels. An investor could move out the curve to pick up coupon income without taking on more risk and then ride the position down the curve, adding to total return. This strategy of “playing the pattern of rates” led investors to prefer bonds to bills. Their preferences, coupled with the Treasury’s decision to issue in all maturity sectors, forced the Open Market Account to buy unwanted bills and to sell the more attractive bonds. By late 1945 the Account held 75 percent of outstanding bills, but—in spite of heavy bond issuance by the Treasury—fewer bonds than it had held in late 1941.

The essential problem was that the positive slope of the curve was inconsistent with the negligible volatility of rates and the Treasury’s issuance program. In early 1949, Allan Sproul, the president of the Federal Reserve Bank of New York, concluded that “in a supported market in which all obligations might be regarded as demand obligations, a horizontal rate structure would theoretically be required.”

Regaining Control

Following the cessation of hostilities in August 1945, the overarching objective of Federal Reserve officials was regaining control of open market operations. A “cold turkey” approach, abruptly terminating support for the fixed pattern of rates, was never seriously considered. Instead, officials pursued a more measured approach, first terminating the ⅜ percent fixed bill rate, then gradually lifting the caps on yields on coupon-bearing securities, starting with 1-year instruments.

The FOMC terminated the ⅜ percent bill rate on July 3, 1947. Bill yields increased to 66 basis points in July, 75 basis points in August, and 95 basis points by the end of the year. Investors had little incentive to buy 1-year securities at ⅞ percent when bill yields were rising so dramatically and the Treasury was forced to reprice its fall 1-year offerings to 1 percent, and its December offering to 1⅛ percent.

Rising bill rates triggered a reversal of the preference for bonds over bills. In the face of steady selling, bond yields rose from 2.22 percent in June 1947 to 2.39 percent in December and then to 2.45 percent a month later. The Fed sought to cushion the reversal by buying bonds and selling (or running off) bills. In the second half of 1947, the Open Market Account bought $2 billion of bonds while selling or running off $3 billion of bills. In 1948, the Account bought an additional $8 billion of bonds and reduced its bill position by $6 billion.

In late November 1950, facing the prospect of another major war, the Fed, for the first time, sought to free itself from its commitment to keep long-term Treasury yields below 2½ percent. At the same time, Secretary of the Treasury John Snyder and President Truman sought a reaffirmation of the Fed’s commitment to the 2½ percent ceiling.

The impasse continued until mid-February 1951, when Snyder went into the hospital and left Assistant Secretary William McChesney Martin to negotiate what has become known as the “Treasury-Federal Reserve Accord.” Alan Meltzer has observed that the Accord “ended ten years of inflexible [interest] rates” and was “a major achievement for the country.”

Related Reading

Kenneth D. GarbadeKenneth D. Garbade is a senior vice president in the Research and Statistics Group of the Federal Reserve Bank of New York.

How to cite this post:

Kenneth D. Garbade, “How the Fed Managed the Treasury Yield Curve in the 1940s,” Federal Reserve Bank of New York Liberty Street Economics, April 6, 2020,


The views expressed in this post are those of the author and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the author.

Telegraph Journo Embarrassed by Sargon and Robinson’s Free Speech Organisation

As we know, embarrassing the Tories is good and righteous work. So Carl Benjamin, aka Sargon of Akkad, the man who broke UKIP, deserves especial congratulations for making the Tories uncomfortable over the whole question of free speech. He didn’t do it intentionally. It’s just that they found the similarities between Toby Young’s Free Speech Union and a rival right-wing organisation founded by Sargon and the islamophobic thug Tommy Robinson far too close for comfort.

Last month the Spectator’s vile Toby Young announced that he was founding the Free Speech Union along with a load of other rightists. This was going to defend those expressing controversial opinions from being silenced and kicked out of their jobs. The Heil on Sunday quoted Tobes as saying

“People who become the target of ‘Twitter storms’ after making controversial remarks will be defended by a new body called the Free Speech Union. The organisation will ‘stand up for the rights of its members to tell the truth in all circumstances’. The union has been set up by the journalist Toby Young in response to police investigations into a string of ‘non-crime hate incidents’ triggered by outspoken comments”.

“If someone at work writes to your boss to complain about something you’ve said, we’ll write to them, too, and explain the importance of intellectual tolerance and viewpoint diversity. If self-righteous social-media bullies pick on you, we’ll return the fire. If someone launches an online petition calling for you to be sacked, we’ll launch a counter-petition. The enemies of free speech hunt in packs; its defenders must band together too.”

The organisation has a Latin motto, which runs something like ‘Audi altri partem’, which I think means ‘Hear the other side.’

However, it’s not a union, but an incorporated, whose five directors are all spokesmen for the right. They include Young himself, Prof Nigel Biggar, who defends colonialism, Douglas Murray, who has islamophobic opinions, and Radomir Tylecote, who was suspended from the Treasury for writing a book against the EU. And their record of defending their opponents’ right to express their opinions is actually very poor. Zelo Street in their article about the wretched union quoted Paul Bernal, who tweeted

“As Toby Young should know, your commitment to free speech isn’t shown by how well you defend those whose speech you agree with, but how you defend those whose speech you don’t. When his ‘free speech union’ talks about the excesses of the Prevent programme, then see”.

The Street himself commented that it was just free speech for the right, and a way for Tobes and co. to complain about how unfair the world is.

Unfortunately for Tobes’ outfit, Sargon and Tommy Robinson, the founder and former leader of the EDL, have launched their own right-wing free speech organisation, the Hearts of Oak Alliance. And the similarities between the two concerned Tory feminist academic Zoe Strimpel to write a piece for the Torygraph on the first of this month, March 2020, complaining about this fact. Strimpel’s a Cambridge graduate with an M. Phil in gender studies. She’s the author of a series of book on men’s psychology, feminism, dating and romance. She began her article with the statement that her circle of friends has taken on a left-wing hue. It includes many Labour supporters, against whom she has to defend capitalism and Zionism. Well, at least she said ‘Zionism’, rather than accuse them once again of anti-Semitism. She’s upset by them chuckling off her fears about the erosion of free speech and thought, which, she claims, is under attack by a visible machinery of censorship in offices, the cops, universities, arts and online. She cites approvingly a report by the right-wing think tank Policy Exchange, which advised universities to guard against being the voice of critics of those, who despise the supporter of the traditional values of patriotism, family, faith and local traditions. They have to be willing to represent and not sneer at those, who feel justifiable pride in British history, culture and traditions.

However, she was worried whether it was possible to defend free speech, without sullying the cause with too many real thugs, who wanted to get as close as possible to inciting actual violence under the guise of expressing their democratic rights. Was it possible to challenge the climate of intimidation, snide snitching, and mendacious and manipulative accusations of hate-mongering, racism and making people feel ‘unsafe’, without being a magnet for the alt-right? She agreed to become a member of the advisory board, but has her reservations. She’s uncomfortable about Sargon’s and Robinson’s organisations, because of Sargon’s own anti-feminist, misogynistic views. Sargon was, she declared, far right, a thug, who called feminism ‘a first world female supremacy movement’, and ‘all kinds of blokeish’. He’s also the man responsible for sending that Tweet to Labour MP Jess Philips, telling her that he ‘wouldn’t even rape her’.

She concluded her article by stating that the aims of Tobes’ outfit were perfectly legitimate and free speech is under threat. But it was ‘just a shame that in defending those who ought to speak freely, one has to defend those, who – in an ideal world – wouldn’t have anything to say.’

Sargon was naturally upset at this assault on his character. He therefore posted a piece up on his YouTube channel, Akkad Daily, on the 2nd of March defending himself from her attack. He didn’t deny he was anti-feminist, and defended his own comments on this. But he roundly denied being a thug and far right. He was, he repeated, a Lockean classical liberal, and believed in precisely the same values as those Policy Exchange’s report claimed were under attack.

Sargon is indeed far right. He’s a libertarian, who would like everything privatised and the end of the welfare state. He’s against the European Union and immigration, and is bitterly critical of feminism and affirmative action for women and ethnic minorities. And yes, he is an islamophobe like Robinson. But in very many ways he and Robinson are absolutely no different from Young and his crew. Young is also far right. He’s a right-wing Tory, who attended eugenics conferences whose members and speakers were real Nazis and anti-Semites. And Young also is all kinds of blokeish as well. He’s posted a number of tweets expressing his obsession with women’s breasts. Way back in the ’90s, he also wrote a piece for the men’s magazine, GQ, about how he once dressed up in drag in order to pose as a woman, because he wanted to snog lesbians in gay clubs.

And it’s not just the people in the Free Speech Union, who have no real interest in free speech. Neither does Conservatism or Zionism. Thatcher tried to pass legislation making it illegal for universities to employ Marxists. A week or so ago, Turning Point UK announced that it was launching a British version of its parent organisation’s Professor Watch, a blacklist of university lecturers, who dared to express or teach left-wing views. And anti-Zionist and Israel-critical bloggers, like Tony Greenstein and Martin Odoni have described how Israel’s super-patriotic supporters, like Jonathan Hoffman, don’t want to permit free debate about Israel and its barbarous treatment of the Palestinians. Rather, they turn up at pro-Palestinian meetings with the intention of heckling, shouting down and otherwise disrupting the proceedings. They also seek to use the law to suppress criticism and factual reporting of Israeli atrocities as anti-Semitism.

Now there are opponents of free speech on the left. But Stimpel, as a good Tory, doesn’t want to recognise that it exists on the right. She’s embarrassed that supporting right-wing speech also means supporting extreme right-wing figures like Sargon and Robinson. But she doesn’t recognise, because she can’t afford to, that Sargon and Robinson aren’t actually much different from Toby Young, Douglas Murray, Radomir Tylecote, Nigel Biggar and the rest. In fact, there’s little difference between the two groups in fundamental attitudes.

It’s just that Sargon’s a little more extreme and doesn’t have a column in a major right-wing newspaper or magazine.

Blair Warns Labour Party against Culture War over Trans Rights

This is also another story from Friday’s I, for 21st February 2020. Speaking at King’s College London, the Thatcherite warmonger and privatiser of the NHS urged the Labour Party not to get into a war over Trans rights and said he would not have signed the 12-point pledge card that Rebecca Long-Bailey has.

The article, by Patrick Daly, runs

Tony Blair has urged Labour not to get into a “culture war” on trans rights after the issue split the current crop of leadership hopefuls.

The former prime minister has advised the party to avoid signing up to activist pledges on transgender rights – an issue that has dogged the three-horse race to replace Jeremy Corbyn.

“We don’t need to be fighting that culture war,” Mr Blair told an audience at King’s College London yesterday.

“That does mean to say you don’t take the right positions on things.”

Leadership contenders shadow Business Secretary Rebecca Long-Bailey and backbencher Lisa Nandy have both given their backing to the controversial 12-point pledge card issued by the Labour Campaign for Trans Rights.

The pledges have drawn criticism for demanding that members deemed to be “transphobic” are expelled from the party. The document also describes organisations such as Woman’s Place UK, a group that calls for biological sex to be acknowledged as part of maintaining women’s rights, as a “trans-exclusionist hate group”.

Sir Keir Starmer, the shadow Brexit Secretary and third contender in the leadership battle, has not said whether he backs the 12 pledges but has called for transgender rights to be seen as human rights.

Mr Blair said that, rather than signing up to pledges, Labour should instead be engaging with the formal Government consultation on whether those living as transgender should be able to self-identify.

Asked whether he would have signed the LCTR pledges, the ex-Labour leader of 13 years replied: “No, I wouldn’t”.

Meanwhile, Mr Blair’s successor Gordon Brown gave a speech at a London School of Economics event last night where a student asked the former Chancellor what the optimal relationship between the Treasury and No. 10 is.

In response to the question, Mr Brown laughed and said: “That was me and Tony.”

As much as I despise Blair, he’s right on this issue. There are real dangers with the radical transgender lobby, not least in the way their proposals for expanding the definition of transgender and making people question their gender identity could mean persuading mentally and emotionally vulnerable people into transitioning when they don’t need it and would bitterly regret it later.

More specifically, it risks creating another witch hunt in the Labour Party, like that the Israel lobby started with the anti-Semitism smears. That has scores of ordinary, decent people smeared and expelled as anti-Semites for no other reason than they supported Jeremy Corbyn or weren’t sufficiently vociferous in praising or defending Israel.

Blair’s right on the issue of trans rights, but I wish his supporters hadn’t gleefully participated in the anti-Semitism witch hunt. The fact that Blair’s warning against transphobia witch hunt probably means he’s afraid his supporters won’t benefit from it.