I tried taking a break since I had some family commitments, but events have returned. Although I saw an interesting article from a theory perspective that I would like to write about, there have been two big market-oriented topics that have surfaced due to you know who.
Treasury Buybacks
There’s been a bit of excitement about buybacks of 30-year Treasurys at the behest of Treasury Secretary Bessent. There were some market fundamentalist responses, which in my view slightly miss the mark. The correct response to the situation is the following.
Although I am strong believer in “interest rate expectations determine risk-free yields,” there is an important qualification: the market in 30-year bonds is not a two-way market that is self-equilibrating. The financial authority (and the central bank if they go nuts with QE) along with regulatory stances are a major determinant of 30-year spreads versus the 10-year (which is closer to a self-equilibrating rate based on expectations).
Buying back 30-years that you just issued is an idiotic thing to do. If you do not like where the 30-year yield is, get your debt management team to stop issuing the damn things.
I did not bother digging into this story, but my guess based entirely on my prior beliefs is that Bessent did this solely because he wants to be seen doing big things that look impressive to ignorant people.
I have written about the “30-year disclaimer” in the past, so will repeat quickly. At shorter maturities (anywhere under the 5-year tenor for sure, the 10-year might be open to debate) there is an active two-way private sector market in relatively-low risk securities. For example, I believe the rule of thumb is that a brand new 30-year conventional mortgage lines up duration-supply wise with a 7-year Treasury under normal market conditions. Once you are at the 5-year point, there’s lots of credible issuers of 5-year bullet bonds. (A bullet bond has 100% principal repayment at maturity, conventional mortgages are amortising — principal payments occur during the lifetime of the bond — so they have much less weighting on the final payments.)
Private sector issuance of bonds (or borrowing at term rates) are economically equivalent to short-selling duration instruments. So “rate expectations: is not just what some punters at hedge funds and proprietary trading desks think, it is what everybody who borrows thinks as well. If an issuer thinks term rates are too high, they issue a shorter tenor (or float).
Although there has been some popular arguments about government bonds being irreplaceable, that is partly based on mysticism coming down from the 2008 Financial Crisis. In a financial crisis, central government bonds are irreplaceable. However, we are not continuously in the middle of major financial crises where the solvency of the banking system is being questioned. Instead, we have asset prices largely being determined by asset allocators whose primary decision can be (over-)simplified to “stocks versus bonds.” “Bonds” are supposed to be safe assets, but they typically have a smaller weight than equities. Instead of being confined to government bonds, you typically move some of your “private sector risk budget” to the bond portfolio and swap out central government bonds (“govvies”) for “spread product” (anything other than “govvies”). Although asset allocators typically hate bonds, everybody loves using some of their global risk budget to swap in spread product.
Problems arise in ultra-long tenors. Very few entities in the private sector can credibly issue ultra-long bullet bonds, so supply is almost entirely in the hands of governments. (Inflation-linked bonds have an even worse supply story.) Governments as near-monopoly issuers have no choice but to consider what the market will bear. And as the Brits proved in the 1990s, you can have too little supply. Pension fund liability-matching regulations forced funds into buying long-dated gilts beyond the ready supply, resulting in an extremely stupid yield curve.
American debt managers want to pretend that they are neutral and yields are purely market-determined, but that is just ideological silliness at the long end. Their ultra-long supply decisions are ultimately arbitrary. Which means, if the Treasury does not like the price, stop issuing so many of them.
Canada Trade War
The Canadian Trade War erupted again with Trump or other very senior officials allegedly sabotaging a nearly-concluded deal with demands that allegedly amounted to a vassalisation of Canada.
Although the “Conservative” Party of Canada might want to go along with Trump’s demands, they now largely represent a Western Canadian rural rump outside which the demands are complete non-starters. Dismantling French language protections is not going to happen. Even liquor “boycotts” which are recent policies are not easily negotiated away — the decision to pull American booze was provincial, and the provincial governments are powerful and almost inevitably more popular than the distant Federal Government. It would be necessary to bring the provinces into the negotiations. Furthermore, it might not even matter, many Canadian consumers are boycotting American products on their own.
Hight tariffs will be damaging for the Canadian economy, while the problems will be sectoral for the American. On paper, this would imply that the Americans have a stronger bargaining position. The problem is that this is an existential crisis for Canadians, while this is not a concern for most Americans. Pressing the issue would likely just result in an implosion in cross-border relations, not capitulation.
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