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More from @MacroAlf

Alf

@MacroAlf

13 Jul

''Who's buying bonds at nominal yields below foreseeable inflation rates?''
I get this question a lot.

The short answer is: regulatory driven price-takers (pension funds, insurance companies, bank treasuries etc).

The more detailed answer in the thread below.
1/n

Let's start from Bank Treasuries.
After the GFC, regulators introduced the Liquidity Coverage Ratio (LCR). It forces bank to own a stock of High Quality Liquid Assets (HQLA) to counter sudden strong outflows of deposits.
Cash and bonds are both HQLA.
Bonds often yield > cash.
2/n

You can't compare a 10y bond with overnight cash.
For a Bank Tsy, O/N cash = CBk depo rate. The term structure for the CB depo rate is the Overnight Index Swap (OIS) curve.
10y bonds should be compared to 10y OIS swaps.
Treasuries pay you OIS+30 bps on avg.
You buy them.
3/n

Read 6 tweets

Alf

@MacroAlf

9 Jul

Inside money and outside money.
That's your easy way to think about what operations are (at least short-term) inflationary and which ones are asset price inflationary only.
Inside money never reaches the real economy.
Outside money does.
1/10

If the govt spends money it does not plan to collect taxes for, new outside money has been created.
A bank making a new loan literally credits your account out of nowhere (no deposits or reserves strictly needed, just capital and willingness to borrow/lend).
Outside money.
2/10

Can you see how this might be short-term inflationary? Expansion of credit or net govt spending boosts aggregate demand temporarily. Ceteris paribus and with a small lag, this pushes prices up. 2020 is a prime example: massive credit creation + supply bottlenecks = inflation
3/10

Read 10 tweets

Alf

@MacroAlf

9 Jul

The vicious move in bonds yesterday is imho very justified by peaking global credit impulse and the more hawkish Fed reaction function, but it also has to do with a weird thing called convexity hedging.
A short thread
1/4

If you own mortgages or MBS on your balance sheet and you are funded with deposits, you are subject to negative convexity. When yields fall, people repay their existing mortgages to refinance at lower yields hence the duration of the asset side of their B/S shrinks.
2/4

On the liabilities side, the deposits don’t show a strong enough offsetting convexity pattern. They are stickier to adjust and in some jurisdictions, deposits are even floored at 0%.
So, all of a sudden you find yourself with a shorter duration on a net basis. What to do?
3/4

Read 4 tweets

Alf

@MacroAlf

7 Jul

Some confusion out there in bond land. Let me put some order with a small thread.
10y USTs at 1.3% does not mean fixed income investors expects Fed Funds to be at 1.3% on average over the next 10 years - but much lower.
And why are long term yields collapsing so quickly?

1/4

USTs trade at a spread to OIS, which is the correct term structure for the overnight Fed Funds.
That's mostly because holding Treasuries is balance sheet expensive for dealers - regulation stuff.
10y forward 1m OIS is 1.6%, while spot is 0.09%.
The average is 0.85%, not 1.3%

2/4

30y USTs at 1.95% and 5s30s keep on flattening.
Long-term nominal yields = potential real GDP growth (0.2%) + long-term trend inflation (1.5%) + term premium.
If the Fed tapers into a slowing growth momentum, the distribution of prob around future long-term growth is...

3/4

Read 4 tweets

Alf

@MacroAlf

13 Jun

Why are yields rallying despite a 5% inflation print?
The incentive scheme for risk-takers in the financial industry (think traders and hedge fund PMs) is very important to grasp some of this move.
It's expensive to be short bonds over the summer.
A short thread on this.
1/5

The chart in the tweet above shows the carry and roll you get from being long 5y and 10y Italian and US bonds for the next 3 months. It's not huge but it's positive. It means you have to pay to be short these bonds in a low volatility scenario. Let's see how it works.
2/5

To be short these bonds you borrow them in repo and sell them in the hope to buy later at higher yields. You repo in a 10y Italian bond at -0.55% per year and sell the 10y bond yield at 0.75% per year (both against you). In 3m, you lost (0.55 + 0.75) / 4 = 0.325%. And more.
3/5

Read 5 tweets

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