From February 26th to March 9th negative-yielding debt rose from $14.0 to $14.9 trillion and the Fed of NY increased its balance sheet from $4.16 to $4.31 trillion. Both increases provided liquidity to the system and resulted in a reduction in the 3-month T-Bill yield from 1.53% to 0.33% during the same period. The liquidity increase in late February was in advance on the Federal Reserve’s decision to cut the federal funds rate by 50 basis points. Was that decision in anticipation of the Covid-19 pandemic? The emergency action by the NY Fed was a reaction to problems in the repurchase market, not a change in policy, so it is fair to assume that was the reason.
Then, on March 10th, a new problem emerged for the Fed of NY when negative-yielding debt fell $1.2 trillion in one day from $14.9 to $13.7 trillion. On Thursday the 12th and Friday the 13th, this debt declined another $1 trillion each day to $11.7 trillion. That huge reduction in this debt reduced liquidity. This required the Fed of NY to expand the balance sheet to an estimated $4.4 trillion in the week ending Wednesday, March 16th.
What has occurred in US yields confounded the experts. The 3-month T-Bill yield retreated to a low of 0.30%, while the yield on 10 year T-Note increased from 0.54% on March 9th to 0.95% on March 13th. The higher yields on the long end of the yield curve are directly related to the dramatic reduction in negative-yielding debt by central banks in Japan and countries in Europe. The reduction in debt raised long-term German yields and, therefore, long-term U.S. yields.
The Fed of NY continued to increase the balance sheet into mid-March, prior to the Fed’s open market committee decision on Sunday, March 15th to cut the funds rate by another 100 basis points to zero. The repo problems causing these series of events is directly related to sharp declines in negative-yielding debt. On Monday, March 16th the German 10-year yield rose, from a prior close of -0.54%, to -0.45%, and rose again on Wednesday, March 18th to -0.27%, due to the aggregate of negative-yielding debt falling, from $11.7 trillion on Friday. the 13th to $8.7 trillion on Wednesday. These debt reductions, in turn, creates more liquidity problems in the repo market which leads to more expansion in the Fed’s balance sheet. Yet, while short-term US yields fell to near zero as a result, the U.S. 10-year T-Note yield rose to over 1.2%.
- Why do U.S. long-term yields increase substantially, while short-term yields fall to record lows?
- What is the aggregate of negative-yielding debt, how does it measure foreign monetisation and have control over U.S. Treasury yields?
- Is the change in negative-yielding debt the new measure of monetary growth in a world of negative yields?
- How do changes in negative-yielding debt determine German yields and, in turn, U.S. Treasury yields?
We answer these questions and more in IDC Financial Publishing’s article titled “Understanding U.S. Treasury Yields in a World of Negative Yields.”
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John E. Rickmeier, CFA, President IDC Financial Publishing, Inc.
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