Changes in levels of negative-yielding debt, which is controlled by central banks in countries in Europe and the Bank of Japan, dictate German yields and, through arbitrage, U.S. Treasury yields. In recent years, the most significant impact has been seen in long-term yields.
The Fed balance sheet has increased from $4.16 on February 26th to $4.31 trillion on March 11th. From February 26th, negative-yielding debt rose from $14.0 to $14.9 trillion on March 9th, also providing liquidity to the system. The Fed liquidity injection from increasing the balance sheet on top of the expansion in negative-yielding debt created excess liquidity, thereby reducing the 3-month T-Bill yield from 1.53% on February 26th to 0.33% on March 9th. The liquidity increase in late February was in advance on the Fed’s decision to cut the Fed funds rate by 50 basis points.
A new problem emerged for the Fed of NY on March 10th, when negative-yielding debt fell 1.2 trillion in one day from $14.9 to $13.7 trillion. On Thursday and Friday, the 12th and 13th, this debt declined another $1 trillion each day to $11.7 trillion. By March 19th, this debt declined to $7.7 trillion from the peak of $14.9 trillion, a $7.2 trillion contraction. That huge reduction in this debt reduced system liquidity, requiring the Fed of NY to expand balance sheet to an estimated $4.4 trillion in the week ending Wednesday, March 16th, as the repo market continued to be the problem.
What has occurred in U.S. yields confounded the experts. The 3-month T-Bill yield retreated to a low of 0.02% on March 18th, due to excess liquidity as a result of the expansion of the Fed’s balance sheet. At the same time, the yield on 10-year T-Note increased from 0.54% on March 9th to over 1.2% on March 18th. 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 countries in Europe and Japan, raising German yields on the long end of the curve, therefore U.S. yields.
On March 20th, these foreign central banks again reversed course by increasing negative-yielding debt from the low of $7.7 to $8.6 trillion, an increase of $900 billion in a day. This reversal reduced the German 10-year yield from -0.15% to -0.34%, and, therefore, the U.S. 10-year yield from over 1.20% to 0.88%. The debt increase also took the liquidity pressure off the repo market. This reversal delays the forecast for the German 10-year yield rise to zero and the U.S. 10-year rise toward 1.75%. A future major decline in negative-yielding debt would signal the peak in the global shutdown, a return to work, and the beginning of the end to the Covid-19 crisis.
- 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 monetization and how does this control U.S. Treasury yields?
- How do changes in this debt impact liquidity in the repo market?
- Is the change in negative-yielding debt the new measure of monetary growth in a world of negative yields?
- How does the change 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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