"Quantitative Tightening" Or "Operation Twist" Is Coming Up. What Are The Implications For Bonds?

SAXO

Economic

Bond

Central Bank

Summary:

Waller's comments at the 2024 US Monetary Policy Forum in New York may provide insight into what will happen next.

Last week, Federal Reserve Christopher Waller's speech discussed Quantitative Tightening (QT) in the past, the present, and the future. Yet, the following remarks were particularly important for bond markets:

1. The Fed’s agency MBS holdings should go to zero

2. US Treasury holdings should shift toward a larger share of shorter-dated Treasury securities.

To understand how such comments affect US Treasury and the yield curve, it is essential to know that today, T-Bills holdings are less than 5% of US Treasury Fed holdings and less than 3% of total Fed security holdings. Before the Global Financial Crisis (GFC), they comprised a third of the Federal Reserve portfolio.

Although Waller doesn't clearly state whether he would like to go back to a composition similar to the one seen before the GFC, it’s clear that he would like to limit QT to runoffs in MBS and coupon US Treasuries and avoid any runoff in T-Bills.

The issue is that QT is running at a rate of $60 billion US Treasuries per month and $15 billion agency MBS per month. The way QT works is that coupon bonds and notes are run off before T-Bills, but when the redemption of notes and bonds does not reach $60 billion, then T-Bills will be run off up to the $60 billion cap.

According to the Federal Reserve redemption schedule, US note and bond redemptions will meet or exceed QT’s cap in only five out of twelve months. If the current pace of QT remains unchanged, T-Bills will be runoff for roughly $170 billion in a year. "Quantitative Tightening" Or "Operation Twist" Is Coming Up. What Are The Implications For Bonds?_1

"Quantitative Tightening" Or "Operation Twist" Is Coming Up. What Are The Implications For Bonds?_1

In 2019, MBS securities exceeding the QT cap were reinvested in US Treasuries in the secondary markets up to $20 billion; anything above that amount was reinvested in MBS. While one might think that the central bank today could opt for the same solution, it won't be able to do so this time. For the remainder of 2024, there will be only $14 billion of MBS redemptions, resulting in an average of a little over $1 billion per month, well below the $15 billion monthly QT cap.

Therefore, for the Federal Reserve not to reduce short-term Treasury holdings further, it would need to decrease the QT cap and redirect the debt exceeding the QT cap towards short-term US Treasuries

rather than rolling over the amount in proportion to the amount of SOMA securities scheduled to mature on those dates.

Another option would be to engage in a reverse "Operation Twist." The Federal Reserve implemented Operation Twist in the second quarter of 2012, which implies the simultaneous selling of short-term bonds to purchase long-term Treasuries.

Either way, QT tapering is indispensable and may come as soon as the next FOMC meeting on March 20th. Indeed, the Fed RRP facility has fallen below $500 billion this month for the first time since 2021, and the BTFP facility expires this month.

QT tapering or operation twist might be coming exactly as the US Treasury is increasing its T-Bill shares above the 20% guideline.

"QT tapering" and "Operation Twist Reverse": consequences on the yield curve.

The above is likely to result in a steeper yield curve. However, the big question is whether QT tapering or operation twist is going to be bullish for long-term US Treasuries, especially the ultra-long part of the yield curve, where many investors have put their money at work in the past couple of years, positioning for an early and aggressive rate cutting cycle. Even during February, when markets were pushing against expectations of more than three rate cuts in 2024, TLT (iShares 20+ Year Treasury Bond ETF) saw inflows of $776 million.

Although the announcement of QT tapering per se is dovish, as it alludes to easier upcoming monetary policies, long-term US Treasury yields will be able to decline only once the market is confident that inflation is on a sustainable path to 2%. Moreover, considering that the US Treasury is maintaining coupon issuance to pandemic-like levels in the year's second quarter, long-term yields look more likely to rise rather than fall.

Yet, the front part of the yield curve up to 7 years offers an appealing entry point, as policymakers' reluctance to tighten the economy further and reduce liquidity in the system will likely favor this part of the yield curve. We continue to remain cautious. "Quantitative Tightening" Or "Operation Twist" Is Coming Up. What Are The Implications For Bonds?_2

"Quantitative Tightening" Or "Operation Twist" Is Coming Up. What Are The Implications For Bonds?_2

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Warren Takunda

Economic

Traders' Opinions

Cryptocurrency

Crypto Enthusiasts Rejoice as Bitcoin Hits Record High: But Is the Rally Sustainable?_1

Cryptocurrency enthusiasts are jubilant as Bitcoin recently hit an all-time high, surpassing $69,000. This milestone marks a significant moment for believers who weathered the storm of a tumultuous 2022, marred by industry downturns and corporate bankruptcies. However, the question looms: Is crypto truly experiencing a resurgence, or are there underlying differences between this rally and the previous boom?

The collapse of cryptocurrencies in the past was a sobering reality check for many investors. The frenzy of 2021, characterized by extravagant marketing campaigns and celebrity endorsements, gave way to a harsh reality in 2022. Scandals and fraud rocked the industry, leading to significant losses for those heavily invested in digital assets. The collapse of FTX crypto exchange in November 2022, costing customers billions, marked the nadir of this downturn.

Bitcoin's remarkable rebound since then can be attributed to several factors. A pivotal moment arrived in August when a court ruling opened the doors for financial institutions to offer Bitcoin-based investment products, namely exchange-traded funds (ETFs). These ETFs provided a safer avenue for investors to participate in crypto markets without directly owning digital currencies, thereby mitigating some of the risks associated with traditional crypto investments.

Unlike the 2021 boom fueled by retail investors seeking quick gains, this resurgence is marked by institutional support. Bitcoin's rally has been buoyed by endorsements from major financial players like BlackRock and Fidelity, both of which offer Bitcoin ETFs. This institutional backing signals a shift towards a more mature and stable market, with potential for sustained growth.

However, despite the optimism surrounding Bitcoin's surge, uncertainties linger regarding the broader crypto industry's future. Regulatory challenges loom large, with federal agencies scrutinizing platforms and digital currencies beyond Bitcoin. Lawsuits filed by the Securities and Exchange Commission against Coinbase and other major players underscore the regulatory hurdles that could impede the industry's growth trajectory.

Crypto enthusiasts remain bullish, projecting further gains for Bitcoin in the coming months, with some even forecasting a price surpassing $100,000. Yet, the industry's long-term prospects hinge on navigating regulatory complexities and building trust among regulators and investors alike.

In conclusion, while Bitcoin's recent rally signals a potential resurgence for cryptocurrencies, the road ahead is fraught with challenges. Regulatory clarity and institutional acceptance will play pivotal roles in shaping the industry's trajectory, determining whether crypto truly emerges from its past shadows into a new era of legitimacy and stability.

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Alex

Economic

Yuan financing is becoming costly and sparse in Russia, choking off a pathway to foreign capital for companies that are already facing much higher domestic interest rates and a wave of debt due this year.

Two years after the invasion of Ukraine isolated Russia from the Western financial system, major energy and mining companies have come to rely on the yuan for most of their foreign-currency needs. But even as yields on China’s benchmark government bonds hover around a two-decade low, insufficient yuan liquidity in Russia and demand for the currency from importers are contributing to higher borrowing expenses.

The funding dilemma leaves companies like Russia’s biggest miner, MMC Norilsk Nickel PJSC, choosing between expensive ruble funding or the rising cost of domestic yuan debt. Russia’s Chinese Yuan Funding Lifeline Is Getting Too Expensive_1

Russia’s Chinese Yuan Funding Lifeline Is Getting Too Expensive_1

Russia more than doubled its benchmark last year, saddling corporate borrowers with as much as 1.2 trillion rubles ($13 billion) in extra debt-servicing costs, according to Moscow-based consultancy Yakov & Partners.

“Given current realities, the average cost of debt will be raising,” Sergey Malyshev, Nornickel’s chief financial officer, said in a statement sent to reporters last month.

Nornickel’s interest payments are set to reach $1 billion in 2024 after $800 million in 2023 — compared with $315 million in 2021, the last full year before the war. The burden is nearly as intense for the largest oil producer, Rosneft PJSC, pushing it to accelerate debt repayments after interest consumed 50% more money in the fourth quarter than a year earlier.

Not Widespread

After their debut in 2022, yuan bonds “haven’t yet become widespread” in the Russian market, the central bank said in a report published Monday. It listed limited free liquidity in yuan among lenders and the need to offer higher yields as factors “restraining potential interest in such placements among investors and issuers.”

The volume of Russian corporate yuan bonds – all sold on the domestic market — almost stalled in the final three quarters of last year and reached the equivalent of 800 billion rubles, according to the Russian central bank. And although loans in the Chinese currency nearly quadrupled to a record $46 billion in 2023, their share in corporate credit portfolios was still only in single digits.

The average yield on yuan securities for issuers went up by nearly 2 percentage points in the course of last year and approached 6%, according to the Bank of Russia.

The short-term cost of borrowing yuan on the Moscow Exchange has been so volatile that it spiked to 15.7% on March 1 before dropping to 4.1% three days later, according to calculations by Bloomberg Economics. The reluctance of major Chinese banks to link Moscow’s yuan market with offshore markets is most likely a key factor, according to Bloomberg economist Alexander Isakov.

What Bloomberg Economics Says...

“Yuan liquidity in Moscow is becoming more scarce and its costs more volatile. Yuan shortages in the Russian financial system indicate emerging problems for growing yuan lending for domestic banks — two years after the start of the war they still struggle to attract a sufficiently large and stable yuan deposit base.”

—Alexander Isakov, Russia economist.

Yuan bond issuance in 2022-2023 represented a “cheap source of funding,” according to Alexey Tretyakov, one of the founders of Aricapital in Moscow.

Facing a worsening yuan liquidity crunch, Russian lenders have had to turn to the central bank’s Chinese currency swaps to meet their needs, resulting in a “significant increase in yuan funding costs,” Tretyakov said. “A continued deficit could lead to a further rise in yuan bond yields,” he said.

Russian companies also haven’t borrowed within China itself, according to data compiled by Bloomberg, because capital controls there complicate the repatriation of money abroad. They haven’t sold yuan securities like panda or dim sum bonds since 2018 after 11 such issues in the prior eight years.

The barriers are proving too high to overcome even for the government, which has spent years planning its own yuan bonds. Finance Minister Anton Siluanov said in a February interview with RIA Novosti that discussions with China over taking out loans in yuan also have yet to produce results.

Chinese lenders including Industrial and Commercial Bank of China Ltd. — the world’s biggest by assets — have been ramping up their exposure to Russia through offshore branches. ICBC’s Russian subsidiary alone saw a five-fold increase in total local assets from the start of 2022 and through Oct. 1 last year, according to the latest data published by the Bank of Russia. Russia’s Chinese Yuan Funding Lifeline Is Getting Too Expensive_2

Russia’s Chinese Yuan Funding Lifeline Is Getting Too Expensive_2

The strain on Russian corporate coffers risks depriving industries of capital in a year when refinancing needs are sharply on the rise. Despite stellar profits, companies are feeling the pinch after the government imposed new export taxes to help fund the war, further undermining the benefit of a weaker ruble that helped drive record margins.

“High rates mean that the companies will be more careful with investments that require significant debt capital,” said Dmitry Kazakov, analyst at BCS in Moscow.

Source:Bloomberg

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Warren Takunda

Central Bank

Traders' Opinions

Economic

Forex

Australian Dollar Surges on GDP Data, Heightens Expectations of RBA Rate Cut_1

The Australian Dollar exhibited strength in response to the latest Australian GDP data, reinforcing the belief among analysts that the Reserve Bank of Australia (RBA) is poised to implement an interest rate cut in line with other major central banks.

The Pound to Australian Dollar exchange rate experienced a modest decline, settling at 1.9484, subsequent to the Australian Bureau of Statistics (ABS) report indicating a 1.5% year-on-year increase in Australia's economic output, surpassing the anticipated 1.4% rise.

While the fourth quarter of 2023 saw a growth of 0.2% quarter-to-quarter, a slight decrease from the previous quarter's 0.3% uptick and falling short of the consensus estimate of 0.3%, the Australian Dollar demonstrated strength against most currency counterparts following the data release. However, this surge is likely attributed to the broader strength observed in commodity currencies such as the New Zealand Dollar and the Canadian Dollar.

The Australian Dollar to U.S. Dollar exchange rate climbed by a third of a percent to 0.6523, brushing off the GDP figures, indicating resilience amidst prevailing market sentiments.

Despite the positive market reaction, the prevailing sentiment among analysts remains bearish towards the Australian Dollar outlook. The GDP release underscores signs of economic softness, reinforcing expectations of imminent RBA rate cuts. Real GDP growth of 0.2% quarter-to-quarter and a year-on-year increase of 1.5% fell short of expectations, while household consumption figures also disappointed, growing by a mere 0.1% quarter-to-quarter.

Market forecasts align with the likelihood of RBA rate cuts commencing in September, following similar moves by the Federal Reserve, European Central Bank, and Bank of England. Elevated Australian bond yields relative to peers offer temporary support to the AUD, but analysts caution against underestimating the potential economic slowdown, advocating for a more aggressive rate cut approach by the RBA.

While the market has priced in a September rate cut, expectations diverge regarding the pace of subsequent easing cycles. Analysts anticipate downward revisions to RBA rate cut projections, which could weigh on the Australian Dollar, potentially pushing the AUD/USD exchange rate towards 0.64 in the near term.

Moreover, the resilience of the GBP/USD pair in 2024 hints at further upside for the GBP/AUD exchange rate. The trajectory of the Australian Dollar hinges on Chinese growth trends and shifts in U.S. interest rate expectations, with upcoming events such as Fed Chair Powell's testimony and the Friday jobs report holding significant influence.

The recent boost in confidence towards a potential June rate cut by the Fed following below-consensus U.S. ISM services PMI data could sustain momentum for the Australian Dollar and its commodity counterparts, paving the way for further upside if such expectations materialize.

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Cohen

Central Bank

Economic

A top Chinese official defended his nation’s plan to grow the economy by around 5% this year, a day after the ambitious target was met with skepticism by some economists.

The goal is a “positive target that can well be attained through vigorous effort,” Zheng Shanjie, Chairman of the National Development and Reform Commission, said at a press briefing in Beijing on Wednesday.

He was joined at the event on the sidelines of the National People’s Congress, an annual meeting of China’s rubber-stamp parliament, by officials including Pan Gongsheng, governor of the People’s Bank of China, and Finance Minister Lan Fo’an.

The officials’ comments will be scrutinized by investors seeking details on how President Xi Jinping’s government will repeat last year’s expansion rate in more challenging circumstances without unleashing broad stimulus. Markets were disappointed by the lack of forceful steps announced at the opening of the legislature on Tuesday, while analysts surveyed by Bloomberg ahead of the confab only expected the economy to expand by 4.6% in 2024.

The joint press briefing was the first time in at least a decade that so many economic ministers shared a stage for one conference during the legislative session. Previously, officials typically held briefings in much smaller groups, except for pandemic years when many skipped conferences.

Zheng said China’s plans to issue 1 trillion yuan ($139 billion) of ultra-long special central government bonds this year will drive investment and consumption. He added that China’s “high-quality development” is seeing progress and bringing new competitive advantages, giving the economy a stronger foundation for growth.

Premier Li Qiang’s yearly report to China’s highest-profile annual political meeting kept the fiscal stimulus broadly the same as last year, and avoided aggressive moves to boost consumption or lift a slumping property sector. China’s No. 2 official didn’t directly address the Asian nation’s slide into its longest deflation streak since the 1990s.

The People’s Bank of China is expected to deliver more moderate cuts to interest rates and banks’ required reserves this year. The central bank has used surprise easing steps — such as a record cut to a key mortgage rate — to squeeze more value out of its policy actions in recent months.

Officials managing the world’s second-largest economy are grappling with record low consumer confidence, falling home prices and an increasingly competitive job market. That’s weighed on consumption and led to a price war among retailers, which has been hampered by weakening overseas demand that saw annual exports decline for the first time since 2016 last year.

Source:Bloomberg

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Ukadike Micheal

Forex

Economic

Optimism surrounds the US economy as analysts upgrade their 2024 forecasts, suggesting a potential delay in Federal Reserve interest rate cuts until summer. Strong growth in Q4 2023 and a resilient labor market in January have led economists to revise their GDP forecast to 2%, double the earlier estimate at the end of 2023.

The positive outlook has prompted expectations that the Fed's first rate cut in 2024 might occur in June or July, with three or four quarter-point moves by year-end. This marks a shift from initial predictions of six cuts, beginning in January. However, the buoyant economy poses challenges for President Joe Biden, potentially leading the Fed to maintain higher rates for longer, affecting borrowing costs for home and car buyers.

Despite falling inflation from 7% in 2022 to 2.4% in January, analysts anticipate a cautious approach from Fed Chair Jay Powell. Some even suggest the possibility of no rate cuts until year-end, especially if financial conditions ease and market forces naturally lower bond yields.

Powell's upcoming congressional hearings will likely emphasize the Fed's caution in declaring victory over inflation and stress that rate cuts will only happen when confident in achieving the 2% inflation goal. Analysts expect the Federal Open Market Committee to update its GDP growth estimate during the March 20 rate-setting vote.

Recent data, including a rise in the personal consumption expenditures index and strong January job numbers, support the Fed's hesitancy to cut rates too soon. Analysts attribute the economy's resilience to consumers' willingness to spend, with expectations of a potential slowdown in the second half of the year.

In the face of a robust economy, technical viewpoints highlight the potential impact on market dynamics. The Fed's cautious stance amid strong economic indicators may influence investor sentiment, affecting asset prices and market volatility. As the economy navigates uncertainties, the careful balance between sustaining growth and managing inflation becomes a crucial aspect for both policymakers and market participants.

The evolving landscape of the US economy and Federal Reserve policy signals a delicate dance between optimism and caution. While upgraded forecasts paint a promising picture, the potential delay in rate cuts and the Fed's nuanced approach reflect a complex economic reality. As markets adjust to changing expectations, the interplay of consumer behavior, inflation dynamics, and policy decisions will shape the trajectory of the US economy in the coming months.

Source: Financial Times

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Alex

Economic

Political

Jeremy Hunt plans to put personal tax cuts at the center of his annual budget on Wednesday as he navigates tight public finances to deliver on Conservative demands for a pre-election giveaway to boost the ailing governing party’s standing with voters.

The Chancellor of the Exchequer plans to cut 2 percentage points off the UK’s national insurance payroll tax, according to a person familiar with the matter, who requested anonymity discussing decisions that haven’t yet been announced. While he’s not expected to unveil what would be a more expensive cut in income tax — as preferred by Rishi Sunak team — senior Conservatives have signaled the Prime Minister plans to fight the general election on a promise of future income tax breaks.

With the Tories trailing Keir Starmer’s opposition Labour Party badly in the polls — an Ipsos survey published Monday put the governing party on an all-time low of just 20%, with Labour on 47% — Hunt is responding to Conservative pressure for voter-pleasing giveaways ahead of a national vote due in the next 11 months. He’ll present Wednesday’s move as part of efforts to lift economic growth, according to pre-briefed remarks from the Treasury.

“We can now help families with permanent cuts in taxation,” Hunt is due to say on Wednesday. “Conservatives know lower tax means higher growth.”

For all the Tory demands for tax cuts, Hunt has been hemmed in by tight public finances. The government’s fiscal watchdog, the Office for Budget Responsibility said he had just £13 billion ($16.5 billion) to work with before breaching his own rule to have the national debt falling within five years.

That’s why Hunt has been considering a range of revenue-raising measures to help fund personal tax cuts, including ending UK non-domiciled tax status, squeezing public spending and extending a windfall tax on oil and gas companies.

Hunt “wants to do something that appeals to voters, but faces the reality of fiscal and economic forecasts that suggest there is very little room for maneuver,” said Gemma Tetlow, chief economist at the Institute for Government think tank. “There’s not an easy win or easy giveaways to reach for.”

Hunt will present the national insurance reduction — which was first reported by the Times — as a £900 ($1,140) benefit to the average worker when combined with the identical cut he announced to the payroll tax in his last fiscal statement in November, according to the person. The Treasury declined to comment. Jeremy Hunt Plans To Put Tax Cuts At Center Of UK Budget As General Election Looms_1

Jeremy Hunt Plans To Put Tax Cuts At Center Of UK Budget As General Election Looms_1

Ministers had been considering whether to cut income tax or national insurance. Sunak pledged to reduce income tax during the Conservative leadership contest in the summer of 2022, and some of his aides favored making good on that promise at this year’s budget, believing it would be noticed and understood more by voters in election year. However, income tax is not now expected to be reduced in the budget, people familiar with the matter said.

That’s in part because cutting income tax would be more expensive, at about £13.7 billion a year on average over the next three years for a 2 percentage-point cut compared with £9 billion to £10 billion for the same reduction in national insurance, depending on whether the self-employed are included or not.