This comes on the heels of The Federal Reserve announcing that it provided $80.2 billion in payments to the US Treasury in 2017. This is the lowest remittance to Treasury since 2015, but still positive.
The Fed’s $4.45-trillion of assets – including $2.45 trillion of US Treasury securities and $1.76 trillion of mortgage-backed securities that it acquired during years of QE – produce a boatload of interest income. How much interest income? $113.6 billion.
Which brings us to excess reserves. Excess reserves—cash funds held by banks over and above the Federal Reserve’s requirements—have grown dramatically since the financial crisis. Holding excess reserves is now much more attractive to banks because the cost of doing so is lower now that the Federal Reserve pays interest on those reserves. Excess reserves as of the end of 2017 are around $2 trillion and the interest rate paid on excess reserves is now 1.50%.
In 2017, the interest that the Fed paid the US banks and foreign banks doing business in the US jumped by $13.8 billion to $25.9 billion. The Fed also paid banks $3.4 billion in interest on securities sold under agreement to repurchase. That brings the amount that the Fed paid to banks of $29.3 billion.
The Fed will likely raise rates further this year, perhaps 4 times.
This would push the rate on excess reserves to 2.5% by the end of the year. Excess reserves will likely shrink as QE is being unwound, but I am doubtful. And the amount that the Fed pays the banks this year might surge to $40 billion or more (slow shrinking and rising interest paid on Excess Reserves).
So, Treasury is receiving a windfall every year from The Fed courtesy of QE. And Treasury receives another windfall from the notorious 2012 profit sweep from Fannie Mae and Freddie Mac. (Can you spot Treasury’s changing of the Fannie/Freddie bailout terms??)
Yes, Treasury makes good money from The Federal Reserve and having seized the profits from Fannie Mae and Freddie Mac. Will they relinquesh control?
(Bloomberg) — Trading patterns associated with the new kingpin in volatility options resurfaced on Wednesday, hours before concerns about trade protectionism roiled markets.
The so-called “VIX Elephant” — the moniker bestowed upon the options giant by Macro Risk Advisors head of derivatives strategy Pravit Chintawongvanich — traded more than 2 million contracts, closing out positions in January VIX options and rolling the trade over to same-strike options that mature the following month.
This entailed buying back 262,500 January VIX puts with a strike price of 12, selling 262,500 15 calls, and buying back 525,000 25 calls in order to close out the existing position. Then, the new position was established by selling 262,500 12 February puts, buying 262,500 15 calls, and selling 525,000 25 calls.
This particular trade, which stands to gain should implied equity volatility rise moderately, confirms a definitive shift in the Elephant’s buying and selling patterns.
“While the ‘Elephant’ originally traded three-month options, rolling after two months, they appear to have switched to a one-month cycle,” the strategist writes.
Daily volume in options tied to the Cboe Volatility Index hit their second-highest level on record Wednesday, exceeded only by the last time the Elephant — joined by another mystery volatility buyer known as “50 Cent” — went on the stampede at the start of December.
The 1 year holding period return (HRP) for the VIX is -13.85%.
The timing of that roll proved fortuitous: a spike in implied volatility allowed the Elephant’s previous positions to be closed at a loss of $2 million rather than $20 to $30 million.
However, Chintawongvanich estimates that this trader is down roughly $35 million since then as market calm prevailed.
“More generally, the ‘Elephant’ trades reflect a trend towards low premium outlay hedges with minimal convexity,” the strategist concludes. “Clients we talk to have been more interested in VIX call flies or S&P put flies that carry well and have a fairly low initial cost, but may not mark up as much as an outright option in a risk-off scenario.”
In other words, this Elephant might soon be seeing a new animal on safari: copycats.
The Fed has just begun raising rates (only back to October 2008 levels) and barely unwinding their balance sheet. Apparently, there is considerable concern over an unraveling on the stock market with further rate increases/unwinding.
True, the trade picture is murky as is The Fed’s will to further raise rates and unwind its balance sheet.
10-year Treasury note volality remains extremely low with all the Central Bank microaggression.
Bloomberg News — China added to bond investors’ jitters on Wednesday as traders braced for what they feared could be the end of a three-decade bull market.
Officials in Beijing reviewing the nation’s foreign-exchange holdings have recommended slowing or halting purchases of U.S. Treasuries, according to people familiar with the matter. Benchmark bonds reversed earlier gains on the news, with the yield on 10-year Treasuries climbing for a fifth day.
China holds the world’s largest foreign-exchange reserves, at $3.1 trillion, and regularly assesses its strategy for investing them. It isn’t clear whether the recommendations of the officials have been adopted. The market for U.S. government bonds is becoming less attractive relative to other assets, and trade tensions with the U.S. may provide a reason to slow or stop buying American debt, the thinking of these officials goes, according to the people, who asked not to be named as they aren’t allowed to discuss the matter publicly. China’s State Administration of Foreign Exchange didn’t immediately reply to a fax seeking comment on the matter.
“With markets already dealing with supply indigestion, headlines regarding potentially lower Chinese demand for Treasuries are renewing bearish dynamics,” said Michael Leister, a strategist at Commerzbank AG. “Today’s headlines will underscore concerns that the fading global quantitative-easing bid will trigger lasting upside pressure on developed-market yields.”
The Chinese officials didn’t specify why trade tensions would spur a cutback in Treasuries purchases, though foreign holdings of U.S. securities have sometimes been a geopolitical football in the past. The strategies discussed in the review don’t concern daily purchases and sales, said the people. The officials recommended that the nation closely watch factors such as the outlook for supply of U.S. government debt, along with political developments including trade disputes between the world’s two biggest economies when deciding whether to cut some Treasury holdings, the people said.
The yield on 10-year Treasuries was four basis points higher at 2.59 percent as of 12:16 p.m. in London, reversing a decline to 2.54 percent earlier Wednesday. The rate on comparable bunds was one basis point higher at 0.53 percent.
Any reduction in Chinese purchases would come just as the U.S. prepares to boost its supply of debt. The Treasury Department said in its most recent quarterly refunding announcement in November that borrowing needs will increase as the Federal Reserve reduces its balance sheet and as fiscal deficits look set to widen.
“It’s a complicated chess game as with everything the Chinese do,” said Charles Wyplosz, a professor of international economics at the Graduate Institute of International and Development Studies in Geneva. “For years they have been bothered by the fact that they are so heavily invested in one particular class of U.S. bonds, so it’s just a question of time before would try to diversify.”
Some investors said that the market could take the China news in its stride considering the nation’s net purchases of Treasuries have already slowed “significantly.”
“If China ceases to be a net purchaser of U.S. Treasuries, this is unlikely to have a significant impact on the overall yield curve unless China divests a large share of its total holdings in a short time period,” said Rajiv Biswas, Singapore-based chief Asia-Pacific economist at IHS Markit.
Yields were already climbing this week amid expectations the improving global economy will boost inflation pressures round the world, just as major central banks scale back their asset purchases.
Markets are also braced for a deluge of debt supply this week. The U.S. is scheduled to reopen $20 billion of 10-year debt later today, followed by $12 billion of 30-year bonds on Thursday. Germany sold 4.03 billion euros of 0.5 percent 10-year bonds on Wednesday with syndications in Italy and Portugal to follow.
Yes, China is the largest holder of US Treasuries AFTER the New York Federal Reserve, followed by Japan and Ireland.
But since 2012, both China and Japan has slowly decreased their holdings of US Treasuries while the New York Fed has greatly increased their position (better known as QE3).
Yes, the Chinese government is comtemplating an Escape from the New York (Fed) in the face of rising interest rate and trade squabbles with Washington DC. We shall see if it is bluff by China or not.
The Federal Reserve doesn’t activley manage its interest rate exposure on its over $4 trillion balance sheet. Yet it purchases and sells Treasury Notes/Bonds and Agency Mortgage-backed Securities (AgMBS) in a measured way to impact interest rates.
[W]hen it is time for us to sell, or even to stop buying, the response could be quite strong; there is every reason to expect a strong response. So there are a couple of ways to look at it. It is about $1.2 trillion in sales; you take 60 months, you get about $20 billion a month. That is a very doable thing, it sounds like, in a market where the norm by the middle of next year is $80 billion a month. Another way to look at it, though, is that it’s not so much the sale, the duration; it’s also unloading our short volatility position.
… we look like we are blowing a fixed-income duration bubble right across the credit spectrum that will result in big losses when rates come up down the road. You can almost say that that is our strategy.
I hope Powell’s messaging skills have improved since 2012 when he uttered these words. He does sound more like billionaire Thurston Howell III than a future Fed Chair.
Yes, The Federal Reserve can manipulate interest rates through its policies and INFLUENCE the volatility and duration of Treasuries and Agency MBS. (He should have made that clear, particularly for Agency MBS).
Here is a chart of U.S. JP Morgan Treasury Investor Sentiment Active Client Net Long positions are The Fed has been SLOWLY unwinding its Treasury Note/Bond portfolio over the past year. Notice that net long sentiment is in negative territory.
For Treasury shorts, the investor sentiment has been rising with the slight T-note/bond unwind.
10-year Treasury Note volatility remains repressed despite the teeny sales of The Fed’s balance sheet.
It really does look like The Fed is scared to actually try to unwind its balance sheet, particularly for Agency MBS extention risk where duration (risk) rises with rate increases. Particularly since we are in a low rate environment where small rate increases can crush note/bond/MBS prices.
Here is a photo of the next Fed Chair, Jerome Powell.