A Granular Look At Primary Dealers' Holdings Of Treasuries; Visualizing The Curve Trade
One of the key observations of 2009 has been that Primary Dealers, courtesy of their access to the Primary Dealer Credit Facility, and, of course, to the Discount Window, are the critical cog in the Fed's plan to push markets ever higher. In a fashion, the banks that make up the PD community are the designated proxies of the Federal Reserve, allowing it to execute its trading strategy when its own traders at 33 Liberty are having a Starbucks break. As the PDs can pledge any worthless asset to the Fed, for which they get a dollar equivalent of 100 cents on the dollar, the PDs can leverage whatever toxic residuals they have on their balance sheet massively without even using explicit leverage, merely thanks to the Fed's lax standards in accepting practically any collateral. We have had occasional glimpses into what "assets" make up the tri-party repo system that is the backbone of the US financial system, but absent a full blown evaluation and transparency of the Federal Reserve, only the Fed (and specifically its New York branch) and Jamie Dimon really know the state of affairs when it comes to pledge collateral. However, there is some information that we can glean on the broader sense of risk within the Primary Dealer community, which is possible courtesy of the NY Fed's disclosure of the PD's transactions and net holdings by various asset classes. Our focus in this post are the Primary Dealers' transactions and holdings in US Treasuries.
The first chart below summarizes the weekly volume of all treasury transactions. After peaking at about $600 billion weekly, the 6 month transaction Moving Average declined by nearly $200 billion after the collapse of Lehman Brothers. And even as the market has gradually revived, the 6MMA is still about $100 billion below the past 3 year's average. Note the spike in Treasury transactions in the September 15, 2008 week: the $811 billion traded that week was the third highest weekly total ever. In the year since then, the peak has been far lower at $550 billion. It appears that the reduced volume in stock transactions is being mirrored by Primary Dealers in their bond purchases and sales.
A more granular read of the data, with a stratification by various Treasury maturities, indicates that there has been a material shift in the trading of Treasuries with a 3 - 6 year maturity interval in favor of T-Bills, where trading has nearly doubled from the long-term average.
When one looks at net holdings of US Treasuries within the Primary Dealer Community one can notice that since the market peak in 2007, when PDs held a net short position of almost ($200) billion, dealers have built up an almost $200 billion buffer, with the most recent net holdings standing at just over $10 billion. In early June, this number stood at almost $100 billion, and has since declined by about $90 billion.
Digging deeper, one can see that PDs have been accumulating the biggest positions in Bills (essentially as a cash replacement) and also in Coupons with a 6-11 year maturity. Could this be the preferred sweet spot for the PD community, or their clients? The one Bond class that is least desirable is anything with a maturity under 3 years.
Indeed, the Net holding differential between the Sub-3 year Maturity and the 6-11 Year Maturity has recently blown out to a record high. Can you spell steep yield curve? This is how the Primary Dealers are taking advantage of free money graphically. The chart below subtracts the net (lately mostly short) position in sub 3 PD holdings from 6-11 Year Net holdings. The steepness of the holdings curve is only matched by the steepness of the actual bond yield curve.
PD T-Bill holdings indicate that this security class is still seen as a simple cash replacement. Oddly, the fact that PDs still have such historically high Bill holdings indicates that all is far from clear, at least at seen by the PD community. An odd observation: T-Bills hit a record on June 3, when over $90 billion in Net T-Bills was being held on bank balance sheets. Since then this amount dropped to flat by November and has since surged again. Whether this is merely end of year window dressing we should know in a few weeks when the January 1st results come out.
The most obvious observation is that PDs are doing nothing unexpected: they are loading up on the curve, by shorting the near-end and purchasing the far-end. The only question is whether and to what degree they do this for themselves as opposed their clients. And a read of PD T-Bill holdings, especially in the context of TIC data, highlights that there is still either some major liquidity concerns permeating both the International and Primary Dealer community, or just a very rampant case of window dressing as asset managers at both banks and funds get risky-asset buyer's remorse and try to make it seem that they are actually somewhat prudent. Of course, should the Fed be unable to find the much needed $2 trillion in buyers for various US fixed income securities, the "window dressing" approach will seem sadly ironic, as numerous hedge funds implode if indeed there is a massive rush from risky to "risk-free" assets.