Odd Lots - Zoltan Pozsar on What Just Happened with the Treasury Market

Episode Date: March 4, 2021

The Treasury market just experienced what some might call a tantrum. Across the yield curve, we saw rates shoot up. And it's not even clear why it happened. There was no comment from a Fed official like there was with the 2013 taper tantrum. No single datapoint that stood out. On this episode, we speak with Credit Suisse's famed strategist Zoltan Pozsar about what happened to cause this selloff, what it says about Treasury market structure, what reforms may be coming down the pike, and whether the Fed needs to act further to restore order to the market.See omnystudio.com/listener for privacy information.

Thanks for listening to Odd Lots. Follow the show on Amazon Music for more future episodes or just ask, Alexa, play the Odd Lots podcast on Amazon Music. And welcome to another episode of the Odd Lots podcast. I'm Tracy Alloway. And I'm Joe Wisenthall. So, Joe, it's, well, there's been a bit of drama in the treasury market once again. Yeah, I noticed you got to do one of your Tracy Alloway signature things where you talk about a move that happened. that's only supposed to happen like once every three billion years. Yes, I love talking about those because it really gives everyone the opportunity to show that they've read Taleb's books by saying that the world isn't normally distributed. But of course, we did see some pretty big moves in the

Treasury market. So first of all, the 10-year yield jumped up to 1.6%. This was in the last week of February. but the really big move came in the five year, and I think that one had something like a seven or eight standard deviation move, you know, one of those things that's only supposed to happen in like 10 billion years kind of things. And really, I know people make fun of standard deviations and Sigma events, but really we're talking about the world's most liquid market. And stuff like this keeps happening. This is, I think, the fourth big, uh,

bout of treasury market chaos that we've had in just a couple years. So I'm thinking back, we had one in, what was it, September 2019. We had repo madness. Then we had the March chaos in 2020 with the levered UST trades blowing up. And then we had a mini rates blowout in October 2020. And now we just had the most recent incident. So something is going on. And clearly there is a persistent issue in the U.S. Treasury market. Yeah, there's a lot of things going on at once these days because there seems to be ongoing structural issues. Questions about liquidity, which is weird in, A, the world's most deep and liquid market, and B, a market in which the Fed is actively supplying a lot of liquidity or very active in the market. And then, of course, it's interacting with the economic

situation and the policy situation because we have this Fed that said, we're not. not going to raise rates until the economy hits these benchmarks and everyone's watching to see the Fed's credibility. We also have a very rapidly improving economy. We have people warning about inflation for the first time. So all kinds of things happening at once. But yes, to your point, the big action, we've seen rates at the long end, 10 year, 30 year yields have been rising for a while since the middle of last year. But it's really the action at the shorter end that's striking here. Yeah. And of course, one of the weird things about last week is you mentioned the economy. but we have this big tantrum in bond yields without a corresponding taper, I guess. So we kind of had

a taperless tantrum because not that much changed last week. We didn't have Fed speakers talking about rates rising or anything like that, but we have this huge move in the bond market. So a lot of focus on microstructure at the moment, a lot of focus on liquidity, ease of trading, and the overall organization of the treasury market. And we have. perfect person to talk about all those things. We're going to be speaking with Zoltan Pozar from Credit Swiss. I can't wait. Let's do it. Yeah. So Zoltan, I should say, in addition to being a strategist over Credit Suisse, has also been on the Odd Thoughts podcast multiple times. So we will be getting you that tote bag any day now, Zoltan. Thank you so much for coming on again. Thank you very much for

having me. I should just say one more thing, which is that every time there's any volatility in the rates market, someone ibiz me and says, you guys got to get Zoltan on again. It happens every time anything ticks higher on some screen of like overnight funding rates or whatever. They're like, when do you have Zolten back on the episode? So this is a lot of requests for this one. Sorry, go on. Okay, well, on that note, I mean, why don't we start out with a big question? So every time there's some sort of chaos in the rates market. Joe gets an IB asking for you to come on the show. There have been a lot of those over the past couple of years. And as we were discussing, that's something you wouldn't necessarily expect for the world's most liquid market.

So what's going on here? And why do we keep getting these sort of mini blowups in rates? I think people get shaken out of their positions all the time. I mean, just to maybe set the set the stage for the conversation, I think there's a number of things that are happening that has happened last week. For a number of weeks now, and really since the Democratic win and the blue sweep, you know, the treasury curve has been steepening quite remarkably. I mean, relative to the slope of curves in Germany, in France, in Japan, you know, the U.S. Treasury curve has gotten quite steep for a number of reasons. You had the blue sweep. You have the vaccine rollout, which is happening in the U.S., more rapidly, perhaps, than in other parts of the

world. You have the market starting to price in recovery, the market trying to price in the inflation outlook. And the market is, you know, getting excited about the idea that with inflation will surely come some Fed action and the Fed is going to, you know, try to chase down inflation or keep it in check. And so all of these things, I think, have driven the steepening of the curve. But You know, the interesting thing is that the steepening of the curve has been fairly orderly. Okay. And so what happened last week was a little bit plumbing related. But again, the underlying structural driver of rising yields has been more fundamentally driven. What happened last week, I would say that there were two central banks that were quite a bit in the headlines last week and that got the markets a little bit jittery. I think there were some headlines around the RBNZ, and there were some headlines around the RBA.

You know, with the RBNZ, I think what didn't help the situation was the market interpreted the headline that the finance minister of New Zealand has forced a new mandate on the Reserve Bank of New Zealand, which is, you know, house price targeting and house prices have been through the roof in New Zealand. And so hikes are coming because of that, which is absolutely not the case. I mean, you know, the RBNZ policy mandate is pretty much unchanged. I mean, they have their price stability mandate. They have their full employment mandate. They have their financial stability mandate. And all that has happened is that that financial stability mandate get a more explicit piece to it, which is, you know, looking at house prices more carefully in the future, particularly house price dynamics,

driven by second homebuyers and invests. investment property buyers. That was number one. Number two, the RBA had breached a yield curve target. Okay. And so the market was looking very closely at the three-year point in the Australian government bond market. And it got, you know, one basis points, two basis point, three basis points higher than the yield curve target. And the RBA didn't really do anything. And so because the RBA it was slow to respond to the breach of that yield curve target. I think the market got quite spooked by that. You know, Australian accounts did try to get long Australian bonds,

but, you know, things were moving so fast and prices were getting so much that they got, you know, limit down very quickly. So if you couldn't take advantage of the sellout in the Australian yields, what a lot of accounts in Australia have done is they have rather shorted U.S. treasuries. And so now we are in a Tuesday, Wednesday time frame. And then by the time we got to Thursday in the U.S., we had a scheduled seven-year auction, and that auction went absolutely horribly.

It was one of the most undersubscribed in recent memory. I forget how far you have to go back to find something as lowly subscribed. And, you know, that also had some technical drivers to it, because, you know, in the U.S. we are in this kind of no-man's land from a regulatory perspective where the bank portfolios, that are normally have a big presence in these, in these auctions have been a bit on the sidelines lately because there's a big question mark in the US regarding, you know, the SLR treatment of, of treasuries, you know, is it going to get extended, you know, the exemption from the SLR or not? So there was a lot of uncertainty about that. And then, you know, you mentioned the five-year point.

I mean, it so happens that, you know, a popular trade in the U.S. has been, you know, people shorting the five-year. year and being short the five year and long the 30 year. And, you know, as all these rates market dynamics were happening and the market was, you know, questioning central banks commitments to low rates for a long time, I think, you know, people were just shaken out of these carry positions. And, you know, we have a financial system that is highly levered because rates are so low, right? So one way of generating a decent amount of return with low risk, low yielding assets is you lever it up. Every time you have a change in expectations and your understanding of the world. And for how long the central banks are willing to stay accommodative, you get shaken out of these positions.

And things are quite volatile when that happens. So there's obviously quite a bit going on here. And the way you laid it out is really great. And of course, it seems like a classic finance thing that, even though there's a lot of different things, somehow it randomly gets kicked off by policy choices at the Reserve Bank of New Zealand. Zealand or the Reserve Bank of Australia and then it spills into there. You mentioned the SLR and the questions about that. And in fact, some of the IVs that I get when they want to hear you on, it's specifically about that. What is it? I'm aware that some decision has to be made at the end of this month that's going to affect bank liquidity, but sort of describe what this sort of, this ambiguity

that's hanging over the market is and how that is affecting rates market liquidity. So this is a big topic. I'm trying to think through how to attack the question. Okay. One, you know, there's lots of ambiguity, right? So, you know, first of all, we have an exemption currently in place, which says that, you know, reserves, just cash at central banks and treasuries that a bank holds are exempt from calculating the supplementary leverage ratio.

So these leverage ratios are much higher because of that. now. And that exemption was put in place in April 1st last year, and it's set to expire at the end of this month, March 31st. And so no one knows whether it's going to get extended, whether it's going to be renewed temporarily or if it's going to, whether it's going to get extended permanently, whether it's going to get taken away. You know, a letter from Senator Brown and Senator Warren during the headlines today. Yeah. They've sent a letter to the Federal Reserve arguing against making this exemption permanent.

There are ideas that have been put forth by the professor Daryl Daryl Duffy at Stanford that, you know, maybe only reserves should be exempted permanently, but not treasuries. That would be more in line with the global standard where, you know, the ECB has exempted reserves, the S&B has exempted reserves, but that exemption, by the way, ended at the end of December already. The Bank of England exempts reserves. So that would be more in line with the international standard. But, you know, the downside of that would be that, you know, the banks would be forced to sell treasuries because, you know, if your balance sheet constrained and only reserves are exempt from the SLR and you bought a lot of treasuries last year, then you will have to sell

all those treasuries. So that's what this. this uncertainty is. You know, when it comes to the SLR relief, there's really two things that you want to think about. The first is that we are not done with QE and we are not done with, you know, the wall of cash hitting the banking system, right? So there's two things on the horizon that we are focused.

The number one, treasury cash balances are coming down. I mean, you know, that's $1.6 trillion dollars of cash sitting in a bank account at the federal reserve. And as those balances come down, reserves in the banking system are going to go up. And number two, QE is ongoing, and it's $120 billion a month.

So, you know, at face value, if all the Treasury's cash balances come down to zero, and if QE proceeds this year, we are going to be adding $2 to $3 trillion of cash into the banking system. And so the banking system does not have the balance sheet to take on to, $3 trillion of cash without SLR relief.

You know, so the thinking goes. And then the other problem is that, you know, the ban on stock buybacks ended and the banks are, you know, getting ready to return capital to shareholders. And if you buy back stock and this SLR exemption does not happen, then you basically are in a position where the banking system is going to return capital to shareholders, that would otherwise have been used to take on more reserves and treasuries in the system. So when we talk about this SLR exemption,

we kind of think about it as this magic bullet that's going to allow the banking system to take on two or three trillion dollars of reserves. So let's assume that SLR exemption happened. You know, this SLR exemption really matters for the handful of big banks that really are key for the US financial system. These banks are JPMorgan, Wells Fargo, Citibank, Bank of America.

I would perhaps put PNC in that bucket as well. So these are the banks that are the big repositories of deposits and reserves and treasury securities. And they are the banks that have been underwriting the fiscal and monetary expansion all of last year. So let's assume that we do this SLR exemption. So what would happen? Would a bank like JPMorgan be in pole position to put on another $500 billion of reserves at the Fed and another $500 billion of deposits as the stimulus checks go out? The answer is no because, you know, JPMorgan has two constraints. It has an SLR constraint and it has a G-SIP constraint.

So even if you exempt reserves and treasuries from the SLR, you know, that bank is still not going to be in a position to take on massive amounts of new. deposits and additional reserves and additional Treasury securities because that would push their GSI score and their GSI surcharge from 4% to 4.5%. And their management has repeated a number of times that they don't want to have a higher GSI score and they don't want to higher capital ratio than 12.5%. So SLR exemption or not, JPMorgan is not in a position to take on a large amount of additional reserves. So that's number one. Number two, you know, Wells Fargo, the bank that I have been writing about a lot recently, Wells Fargo is in a unique situation because they are under an asset

growth ban, okay? And they have been put into that place because of, you know, past issues they have had. And the Fed has put them in this asset growth ban position. So, you know, the analogy there is if you think of the U.S. financial system as a 7-4-7, a Boeing 7-4-7, it's really, really had been, it really has been flying on three engines because the fourth engine, you know, is just not working at the moment. That's Wells Fargo. You know, if you have an SLR exemption, you're still not going to help Wells Fargo because they can't grow their balance sheet much. Okay. So that's, that's the second thing. The third, city bank is, you know, it's a unique creature, right, because it's half global, half US. It's mostly an institutional bank, not a retail

bank, so it doesn't have as big a retail presence as JP Morgan or Bank of America. So So, as all the stimulus checks are going out and all this cash is coming into the system, their deposit growth is not going to be as big as it would be for JPMorgan and Bank of America. And the other thing about cities that they have flatlined their balance sheet since the third quarter of 2020. So they haven't really been growing their balance sheet that much. Then we have Bank of America, which is a bank that would absolutely benefit from an SLR relief because they don't have a GSI issue. like JPMorgan. And you have PNC Bank, which is a large regional bank.

I mean, you would say probably borderline national bank because it's so big. And so you basically have two banks that would be the primary beneficiaries of an SLR relief. Then you need to stop there. Because every time the SED makes a decision about SLR relief and all these changes to the Basel 3 architecture, they do something called a impact study. And the aim of this impact study is to basically quantify, you know, what type of a quantity benefit does the system get by doing this rule change. And, you know, if you come to the conclusion that of all these large banks that we are trying to help,

we are only going to benefit one or two, not the entire class of G-Sibs, should we really do this? are we getting a lot of mileage out of SLR relief? And I think, you know, the answer there is not really because, again, you are going to be looking at five banks and really only two of them are going to be able to absorb a lot of reserves and treasuries. And when you look at the scale of things to come,

you know, two to three trillion of additional liquidity, you know, it's clear that even those two banks are not going to be able to absorb all of that liquidity. You know, so observation number one, you know, how do you justify it when the universe of banks that can benefit from this on scale, i.e. your ability to add balance capacity to the system is not that big to begin there. So I think it's definitely one thing that they are going to look at. The second, because, you know, everything that we talked about is basically about

how do you absorb the additional cash that's going to come into the system this year. The second aspect of it is this. The SLR exemption is very important from the perspective of stock buybacks, right? So a lot of these banks will say we have a lot of access capital. And what that means is that they have a lot of access capital relative to risk-rated assets. You know, risk-created assets are basically loans and, you know, the bank's credit portfolios, but loans have not really been growing. and the banks have had a stock buyback ban that has been in place since April 1st.

So basically all net income that the banking system has been generating for the past 12 months has been retained and that added to banks capital base. So, you know, when the banks are saying that we have a lot of access capital, that's excess capital relative to risk-weighted assets, but it's not access capital relative to all the reserves and the treasuries that have been accumulated last year as the fiscal and monitor stimulus got underway. And so, you know, SLR exemption there is essential for the banks to be able to start returning some of this excess capital to shareholders. But again, you know, that's a capital return aspect and not

necessarily, that will make it easier for the banks to return capital to shareholders, but it won't necessarily add, you know, balance it capacity to, to the system. And I think that's This is why this makes it so complicated as a decision for the Fed. Hello, I'm Michelle Hussein, and for more than 20 years, I was at the BBC. Military withdrawal from Afghanistan. But all the time I was delivering the headlines, I wanted to go further than the news of the day. To spend more time with the people shaping our world. And that's what I'm doing here on this podcast.

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you can count on one essential conversation to help make sense of the world. So please join me, listen and subscribe to the Michelle Hussein show from Bloomberg Weekend, wherever you get your podcast. You certainly ask interesting questions. So I guess two related questions. One, during the February bond market drama, like how much did SLR concerns weigh on dealers,

in your opinion? And I know that you like to call around a lot of the banks and sort of pick up market color when these things happen. So I'm just curious how much that came up. And then secondly, what could the Fed do to sort of relieve balance sheet pressures instead of extending the SLR if you think that it's not necessarily the most efficient way of doing that. Okay. Well, I think the way last week in the Treasury Market and the SLR question are related is actually not through not through the dealer balance

sheets. It's basically the bank portfolios that you want to think about. Right. So every large U.S. Bank is going to have a dealer subsidiary and what's called a bank operating subsidiary. And it's the banks that have all the reserves and all the treasuries. The dealers have obviously a trading book, but in a grand scheme of things, that's tiny. So when you look at an auction that goes bad, okay, a large part for that auction is basically because a bank portfolio doesn't show up because a bank portfolio doesn't know what's going to happen to this SLR exemption. You know, management is getting the balance you're ready for stock buybacks. If you want to buy back stock, you basically,

an SLR exemption does not happen, then you will be, you know, throwing balance sheet capacity away to basically carry liquid assets. And if you do that, you know, it's much better to do that when you have less treasuries and more reserves. So, you know, the SLR exemption angle here

is just basically, you know, had this SLR exemption been resolved already and if we had clarity on it and, you know, maybe if the Fed, you know, extended permanently, you know, then the banks would have been, I guess, more present at that auction. And so things would not have gone that bad. You know, what happens with, with, again, you know, these carry traders getting shaken out of their positions, you know, dealers are going to kind of intermediate these things. But, you know, in real time, I guess, you know, you always have

these air pockets that the dealers have to intermediate through and when the flows go one way and then quickly the other way. I mean, it's never a smooth process. But I would not. say that, you know, dealer's intermediation capacity was impaired by any means because of these slur deliberations. It's more like a bank portfolio, do I show up at the auction and take down those treasuries or not? You get a second question, Tracy, but I forgot what that was. Oh, so the second question was if the SLR, if extending the SLR exemption isn't the most efficient way of fixing this problem, what could the Fed or regulators do instead? Again, I think. I think you have to go back to QE1 and QE1 to QE3, you know, that 2008 to 2015 period to see how the system absorbs liquidity that's put in by central banks.

You know, the reason why I bring up QE1 to QE3 is the status balance had expanded back then a great deal too, but half of that liquidity went to the large American banks. and the other half has gone to the foreign banks. What makes last year an anomaly is that all of this liquidity that was pumped into the system went to the American banks and it stayed with the American banks. You know, when you look at, you know, the foreign banks' holdings of reserves at the Fed, it's been largely flat. Okay. So you now basically have two case studies where, you know, we have a big downpour of liquidity.

It's all going to the American banks. and then we have another downpour of liquidity earlier in history where half of it went here, half of it went there. What is going to happen if the American banks are going to have balance sheet constraint? Well, the system is going to adjust. You know, the stimulus checks that are going to come in, those are going to be hitting people's bank deposits. You know, these are all retail deposits that every bank loves. And, you know, when the stimulus checks go out, you know, it's obviously going to be JP Morgan

and Bank of America and all these big national banks that are. are going to be getting it. But that's going to put them in a position where if they have a fixed quantum of balance sheets, because SLR relief doesn't happen, then they are going to have to take a hard look at their deposit base and say, okay, well, we are getting good retail deposits. We have some institutional deposits to, some of it operating, some of it, non-operating. Non-operating is basically excess cash that these institutions just parked with these large banks. And then, you know, the bank is going to be in a position where they are going to have to turn some of these institutional deposits away.

There's a number of ways to doing that. I mean, you're basically dealing with corporate treasurer, so, you know, you will pick up the phone and try to negotiate with them. You know, I can't really hold it in the bank, but would you mind moving it over to my asset management arm and putting it into a money fund? Or if that doesn't work, you can put a fee on, you know, these deposits. Some of the banks are doing this already. I'm not going to mention Mitch Bank, but one bank, for example, in January, started to charge

institutions for deposit balances that are above their December 31st level. And, you know, that's just a plight way of saying that, look, if you place more cash with me, there will be a fee associated with that. So, you know, that's one way of encouraging depositors to move cash from one bank to another or from the banking system to money funds. And then the third thing you're going to do is you're going to move your deposit trade negative. And, you know, this is not, this is not theoretical because if you look at J.P. Morgan's fourth quarter earnings presentation, you know, they have a very interesting slide on this that, you know, we are now approaching balance sheet constraints. We have all these deposits coming in. The only assets, really, we can

deploy these deposits into is cash at the Fed, which earns 10 basis points. Or we can buy treasuries, which, you know, at the 10-year point, it yields great, but otherwise, you know, treasuries are not not really a good investment opportunity. and banks, to begin, that are not very excited about buying treasuries. And, you know, these are all very low REO-type activities. And low REOE means, you know, you're diluting your bank's performance.

And, you know, if you have a 15% REOE target and all the balance sheet growth that you're getting is happening in these low-spread assets, then you basically dilute with your bank's REOE. So, you know, the point of this page in the earnings presentation was that for us to improve the economic of our business, given all this downpour of liquidity and the system expansion that the set is forcing on the banking system, we will have to move our deposit rates negative because that's the way that we are going to be able to meet our earnings targets. And so, you know, when you bring in this negative deposit rate idea into the picture, then, you know, the picture, you know, starts to fall together because what's happening here is that as the liquidity comes in and a banking system becomes balance sheet constraint,

they are pushing the money away into money funds and the bill market, because not everybody is going to want to invest in money funds. And so, you know, the idea of negative bill yields, which is, you know, a regime where we are, that we are borderline in already, you know, this regime of negative bill yields goes hand in hand with negative deposit rates or fees on bank deposits because, you know, there is so much cash to the banking system just doesn't want to hold it. and, you know, that money is getting pushed around in the system and we are just trying to find a home for it.

And, you know, I'm giving you a very long-winded answer. But basically, what are, what is the technology to basically deal with this, you know, technology, quote unquote? You know, we have a tool for this, which is the reverse repo facility, right? All the money that is going into the money funds, I mean, the money funds need an asset to invest this cash into. And so, you know, really, it would be as simple as whatever the money is, you know, the banking system doesn't want and a money fund get, the money fund should be able to place in the reverse repo facility one for one. But there's one problem in this reverse repo facility. It's cabbed at $30 billion per counterparty, which means that if you're a large money fund

and you have $50 billion of inflows coming at you because, you know, JPMorgan just pushed away $50 billion of deposits, you will only be able to put $30 billion of that in the reverse repo facility. And that remaining 20, you will be investing at rates below. that, you know, potentially at negative interest rates. You know, then the money funds can get into a situation where if I can invest at negative rates only, my marginal inflows, I'm not going to want that money because, you know, a money fund is not supposed to break the buck. And not breaking the buck is possible only if yields in your investment universe are above zero. So a number of money funds that you talk to, especially the larger ones, are contemplating gating inflows and

basically shutting the door to new money. And then you get into a dynamic where the bank doesn't want to get the money. The money fund doesn't want to get the money. So then the bill market remains this kind of alternate shock absorber that's going to take the inflows. And that's how you get to negative bill yields basically between now and the beginning of summer. What is it that the Fed can do? The Fed could simply uncap the use of this RRP facility. And I think that would go at great lengths to ensuring that there is a flexible supply of an asset for the money fund complex, where you can invest cash at least at zero or, you know, the Fed wants to raise the RRP rate from zero to five basis points. Then you have a marginal asset for the money fund complex that pays

five basis points and then, and then you don't have any of these issues. And, you know, that's why I have been arguing in my, in my recent pieces that far more important than raising, The price on the reverse repo facility is to uncap the use of the facility because, you know, if you can only place X amount at five basis points, once you're beyond that amount, you will be lending cash at rates less than five basis points and you still get into these dynamics that I talk about. On April 4, 2023, around two in the morning, a man was found stabbed multiple times on a sidewalk in downtown San Francisco. Hey, who did this to you? What happened next turned the story into a political firestorm. Reports have identified the victim as Bob Lee, the founder of Cash App. From Bloomberg Podcasts, this is Foundering, the Killing of Bob Lee, beginning April 16.

What separates good leaders from transformational ones? I'm Jessica Chen, and in season two of Leading By Example, we'll sit down with executives like Grace Chen of Bertie Gray to find out. It's important to understand where you spike, but also really acknowledge where you don't and find people who can fill those gaps. Listen to leading by example, executives making an impact on the IHeart radio app, Apple Podcast, or wherever you get your podcasts. So we've been talking a lot about plumbing, obviously, and this is sort of the key story and the issue of where to put all this extra cash and the lack of vehicles to place it. you know, we just have, we have a few minutes left. Before we go, I want to get back to something, you know, in your first answer, we talked a little bit also about positioning and how low rates, the only way to compensate for low rates is leverage some of the issues with Australian investors having to short the U.S. Treasury market to sort of hedge the fact that the belly of the Australian curve was blowing out. Let's go back a little bit to that. And how much is that part of the story of this sort of concentrated positioning? CTA flows and how much is that part of the story that we've seen and how much of that is still

built up, how much pent up sort of tension is there, and how much is that dissipated with last week's shock? Look, I think a lot of it has, so positions have shrunk, right? So short the belly along the back end, I think those positions have been downsized relative to last week. I think we also had this, again, this episode of, you know, how committed are central banks to keeping, you know, in the case of the RBA rates in the belly anchored. And I think, you know, the central banks have spoken loud and clear, you know, the ECB has spoken loud and clear about, you know, they don't want any of their yields going higher either. The Fed hasn't really

said anything. And frankly, you know, I don't think, I don't think that they should. I mean, Maybe even, even I was a bit too fast last week, you know, saying that, well, one thing that the Fed could do is a talk rates down, do something like an operation twist, you know, sell front-end stuff and buy back-hand stuff to police the long-end. But here's the point. You know, the long end, you don't really need to police because what you have seen is that you had this massive sell-off. But then, you know, the FX hedged buyers that we talk a lot about on this show, at least when I come on, is, you know, they are now getting a beautiful amount of slope in the treasury curve. And again, keep in mind, every time you talk about all this cash coming into the system, you know, and bill yields going negative, that means that these hedging costs are going to be very well anchored. And if anything, they are going to be going lower. So basically, you know, the sell-off that happened last year, you know, some guys were shaken out of their positions, but that was an opportunity for another set of buyers. Because if you look at these FX hedged yields, I mean, we are back to levels where we have less time being in 2015.

And, you know, that's just great because, you know, when you look at yields in Japan and you look at yields in Europe, I mean, those are still abysmal, right? So any fixed income allocator is going to look at these types of sell-offs with great income. excitement and that's that that was a part of the self-healing mechanism and um you know on Thursday we had a bad day but Friday and since then we've been having a you know great great price action in in Treasury so again you know some people win some people lose but I don't think that the set should do anything about this and again you know I think I think there will be a couple of these instances where you know as the inflation narrative and the reflation narrative is not going to go away anytime soon, you know, that's going to drive yield curve dynamics.

I think, you know, that's a part of the, that's a part of the future outlook. But I'm not sure that, you know, the Fed should do anything explicit about it. I think, you know, even myself, I think I even regret saying last week that, you know, one of the things that the Fed should do, a talk it down, B, do operation twist. I mean, sometimes you get wound up in the emotions of the market, you know, the market has, there's a lot of, you know, self-healing properties, right? And again, you know, the losses for some investors were an opportunity for the FX hedge buyers later on, you know, on Friday and so far this week. So I want to go back to the start of our discussion and just talk very, very broadly about the strength of the U.S. Treasury market in terms of actual

structure and the plumbing. we've seen these instances where liquidity seems to evaporate and, you know, last week wasn't necessarily as bad as what we saw in March, but we did see bid-ask spreads on treasuries start to blow out. How concerned are you about, I guess, the structure of the treasury market or liquidity within the treasury market generally? You know, I think it's a philosophical question. I think, you know, markets are not supposed to be about no volatility at all. In fact, I think is a healthy phenomenon. And, you know, I just don't think moves that we have seen last week. I mean, again, you know,

markets go from one extreme to another, but but for as long as there is a, you know, mechanism whereby some value-based investor is going to provide an outside spread and put a lid on things, that's great. And I think, you know, what I think happened last week is actually, you know, I tend to focus on, you know, the self-healing properties of the market. And from that perspective, I think that the market worked fine. It's just that, you know, some levered players were shaken out of their position because, you know, the market's perception of how committed central banks or to keeping rates low has changed. And then, you know, central banks basically, and the other way and the market calm down.

So, you know, I wouldn't point to, you know, there's too much regulation and that's why the market is trading this way or, or any of that. I think, I think it's just, it's just a healthy development. I mean, it's not comfortable, especially if you're on the wrong side of the trade. But I don't think, but I don't think that we should be going down a path where, you know, we need to redesign the treasury market because there is occasional basketball activity in it.

Well, Zoltan, I think that's a great place to leave it. And we could always talk to you for a few hours. Thank you so much for coming on. We appreciate it. Thanks, Zolten. That was really great. Thank you very much for having me, guys. So, Joe, it's always great having Zoltan on.

And his explanation of the price action last week was probably the clearest one that I've seen so far. And a lot of people were sort of freaking out about this being a central bank miscommunication. or the taper tantrum redux, but actually, like, if anything, it resembled a sort of technical shift in positioning as levered players, you know, rethought their bets. Yeah, there's always a lot of, when rates move violently, you know, we can't really help but ascribe some sort of deep economic significance to them. And people love narratives about, oh, the bond market is challenging the Fed or inflation or maybe something with.

fiscal policy. And I guess that's always there to some extent. And perhaps the sort of the difficulties in communication that maybe the Antipedean central banks have had in New Zealand and Australia kicking things off. They've had sort of problems with communicating about their medium term rate path. But in the end, like when you have a bunch of people who are all levered into sort of roughly the same positioning and you have these other clouds hanging over the market, such as the questions about the SLR that Zolton described, you can just get stuff. It doesn't always necessarily have to have sort of meaning per se. Right. It's sort of the game stop equivalent for the treasury market. Sometimes things just happen. And it doesn't necessarily mean. Oh, God. No, that's exactly right.

I actually thought about it with respect to GameStop. It's like sometimes things just have And just in the same way everyone was like, oh, this is class warfare or this says something about T plus two. It's like, yeah, but sometimes things just happen in market. What was I going to say? Oh, yeah. I also thought it was great that Zolting kind of, I mean, just on the point about the bond market challenging the Fed, which was a narrative that we saw come out in some commentary next week. You know, the Fed can't control the bond market. The bond vigilantes have returned, that sort of thing. I thought it was really interesting. that Zoltan basically said that he regretted writing last week that the Fed could do an Operation Twist or something like that to keep a cap on bond yields. Like he sort of admitted that he was caught up in the moment and that things have changed. But that's like it's not something that you hear from a lot of analysts necessarily, that sort of honesty.

No, totally right. And also this idea, it's like, look like bonds are not equities. And they do have, as he pointed out, this sort of. natural curve mechanism. And we have gotten to the point where there's steepness in the curve such that for foreign FX hedged buyers, there is now value there. A new set of bidders comes in. So, you know, with a with GameStop, you can have an extremely long period of time in which

the underlying, in which the value of the security is extremely divorced from anything resembling fundamentals. And it really seems much harder to have that. It's hard to really even imagine what like a treasury bubble would mean because you do have these sort of natural buyers that come in at certain levels. If you get a disconnect and disconnects do happen between fundamentals and rates, very quickly new sources of money emerge in one direction or another and you don't get the moves going on forever.

I just had a great idea for a financial market novel, which would be, you know, a scenario in which Wall Street bets tries to take on the treasury market and force a squeeze. That'd be interesting. $21 trillion dollar market versus Redditors. Maybe we should write a novel together. We've never been able to come up with a good idea for a like proper finance book together. Maybe the answer is a novel. Let's just go the fiction route. I'd be up for that.

Yeah. All right. Okay. This has been another episode of the All Thoughts podcast. I'm Tracy Allaway. You can follow me on Twitter at Tracy Allaway. And I'm Joe Wisenthal. You can follow me on Twitter at The Stallworth. Follow our producer Laura Carlson on Twitter. She's at Laura M. Carlson. Follow the Bloomberg head of podcast, Francesca Levy, at Francesca Today. And check out all of our podcasts at Bloomberg under the handle at podcasts. Thanks for listening.