January 29, 2024

Quarterly refund announcements may be as important as the Fed for markets this week


Big things are happening this week: the 2023 CPI revision, , , and most importantly, the Quarterly Funding Announcement (QRA) that everyone is talking about.

So, I wanted to share an initial framework to help understand why everyone is interested in the details of Treasury supply announced in the QRA.

It's important to consider bond supply in the context of U.S. monetary policy.

Budget deficit and unemployment

The first thing to understand is the structural change taking place at the policy-making level regarding the use of fiscal deficits.

This chart shows how until 2016, US politicians applied fiscal policy in a counter-cyclical manner.

When it was low (blue), like in 2006-2007, we took a conservative fiscal stance (orange) and reduced the deficit.

Instead, when major crises like 2008 hit and unemployment rose, governments tried to prop up the economy with larger budget deficits.

This is classic countercyclical fiscal policy: injecting new money to support the economy when it needs it, then withdrawing support when the economy becomes overtaxed.

But something changed in 2016.

Since Trump became the new US president, the US budget deficit has begun to grow, even as the unemployment rate has fallen below 5%.

A bit like a crocodile opening its jaws, for the first time in decades fiscal stimulus was used not to prop up a weak economy, but to add on to an already strengthening one.

As a result, the U.S. economy boomed in 2017 and 2018, the Fed raised interest rates, the stock market crashed, and Chairman Powell was forced to change course in 2019.

But it recently emerged that Biden has learned the same trick once he takes office as president.

In fiscal year 2023, Biden has rapidly expanded the budget deficit despite a tight job market, which has opened the jaws of the crocodile again.


Due to the longevity of the U.S. economy, it took a little longer than expected for inflation to start slowing.

As Trump gains ground in the race to become the next President of the United States, one wonders whether he will continue with this new crocodile jaw paradigm. And my hunch is that he will.

US politicians are beginning to understand the power of fiscal stimulus (but not the dangers of its overuse).

And by 2028, the majority of voters will no longer be baby boomers, but millennials and Gen Z who want a change in wealth distribution.

Therefore, we can expect fiscal stimulus to remain in force for a period of time.

Now, back in 2024, the Fed is doing QT and Yellen is going ahead with the deficit.

Below is a visualization of how the financial plumbing for this exercise works.

Government/Federal Reserve Bank

1-2) The U.S. government runs a budget deficit, injecting new money into households and businesses, and (potentially inflationary) bank deposits increase along with reserves in the system.

3-4) At the same time, the bond issuance takes place: Yellen issues the bonds, and banks (primary dealers) use their reserves to buy the bonds at auction.

5-6-7) The Fed has been shrinking its balance sheet through QT, which acts like a net outflow of reserves from the financial system.

Excessive reductions in bank reserves can be problematic for the smooth functioning of the repo market: banks use their reserves to settle repo transactions with each other, but having too much collateral (bonds) in circulation and too few reserves can have adverse effects on the repo market (e.g. in 2019).

But there is a way around this problem: Yellen could issue short-term notes instead of bonds, which is one of the reasons why everyone is paying close attention to next week's QRA.

In this case, QT would not deplete bank reserves but would instead be “sterilized.”

A look at the T-accounts at the bottom shows why: when the government issues Treasury bills and money market funds release existing balances in their RRP facilities to buy Treasury bills, bank reserves do not need to take a QT hit.

It's basically a sterile QT.

Another very important trend is that short-term and long-term Treasury issuances have very different effects on market participants.

While T-Bills have very little interest rate risk, long-term bonds have a lot of duration risk, which is much harder to absorb.

Next week we will take a closer look at the QRA and analyze its immediate impact on the bond and equity markets.


This article originally appeared on The Macro Compass. Join our vibrant community of macro investors, asset allocators and hedge funds. Use this link to find out which subscription level is best for you.


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