Saying good-bye to Treasury as a safe asset

Treasuries have been a safe asset, but it’s unclear whether they still are. A safe asset means that investors will pay a premium to hold it, so there is a convenience yield between it and the next safest asset. Treasuries will trade at a lower yield than AAA-rated bonds. This convenience yield is time-varying. It will change with the business cycle and market fragility. A crisis or recession will lead to higher convenience yields. Similarly, if safe-asset supply increases relative to demand, the convenience yield will decline. Ultimately, perceptions of safety matter. Treasuries are safe because they are viewed as safe relative to other alternatives. The structure and liquidity of the safe asset affect this perception.

Unfortunately, convenience yields have collapsed and are showing no safety premium. This is consistent with a positive stock-bond correlation. Safety from Treasuries relative to the risky asset is limited, given they are moving in the same direction. This is more than a correlation story, so investors should take note of the fall in convenience yield.

 

So what about bond risk - MOVE index has moved lower

A news report creates market buzz, but it is important to look at the numbers: the MOVE index for bond market volatility is still in a longer-term downtrend and is off the high from earlier in the year. The buyback announcements have caught the bond market's attention, but that has not translated into higher volatility. 

Our second graph shows the percentile level over the last ten years as a time series. We are significantly off the high of the high-inflation period. Rates have increased, but this has not translated into market highs in volatility. 

 

More on Treasury buyback operations

 

hat tip Kevin Coldiron - the ideas lab for graphic 

The Treasury buyback program has received considerable attention, but some key foundational information is missing. The current buyback program has been in place since 2024 and can be broken into two parts: the cash management portion is conducted when seasonal tax receipts come due or when the TGA has excess cash to time debt retirement with cash available, and liquidity support buybacks that are tied to specific bonds to ensure that the Treasuries outstanding have added liquidity. We will see both cash management operations and liquidity support increasing, so there will be a larger active player in the bond market.

The amount of debt does not change. Additional bill issuance is used to retire old, less-liquid coupon debt in equivalent size. Yes, there may be more T-bills outstanding to stabilize trading in less-liquid coupons. It can be viewed as refinancing/composition operations. In some sense, buybacks are like the Operation Twist (2011-12) from the Fed because the supply of bills will increase while supply out the curve will decline.

The Fed has stopped its balance sheet runoff but still buys bills to provide ample reserves. The Treasury will issue more bills, so the Fed will buy some of those bills, which will ensure reserves do not change. In the short run, the Treasury may issue more bills, but it can also issue more on-the-run Treasuries to fund buybacks when it makes regular issuances.

Whether you like it or not, the Fed and Treasury will coordinate more. To some degree, these two will coordinate their actions. 

The heat at Jackson Hole Fed meeting - not innovation but inflation

 

The Jackson Hole economic summit has an agenda set in advance, though it is released at the beginning of the conference. The conference agenda focuses on innovation and features some top-flight speakers. The agenda will be interesting, but the real talks will be in private or in the Q&A between the economists. Several Fed officials have spoken out on inflation; however, the audience will want to hear whether Chairman Warsh will clarify his policy thinking.

We will hear at 10 AM EST today.