Reflexivity And Why The Fed Must Sell The Long End

Tyler Durden's picture

Via Global Macro Monitor,

The yield curve is flattening like a pancake.  

Bond_Yield Curve

Tightening cycles tend to do that.


Furthermore, the effective float of 10-year and longer U.S. notes and bonds is relatively small and greatly distorts the bond market signal.   We have written about this several times.

…how small the actual float of longer-term marketable U.S. Treasury securities is available to traders and investors. The data show the Fed owns about 35 percent of Treasury securities with maturities 10-years or longer. Note the data only include notes and bonds and excludes T-Bills.


The Fed’s holdings combined with foreign ownership of longer maturities — more than 1-year — exceeds 80 percent of marketable Treasuries outstanding. The Fed combined with just foreign official holdings, mainly, foreign central banks, is 65 percent of maturities longer than 1-year. Thus, almost 2/3rds of tradeable Treasuries longer than 1-year are held by entities with no sensitivity to market forces.  –  GMM, March 2017

Given the small float of tradeable Treasury notes and bonds,  the market is subject to massive short squeezes if it gets too offside and rapid ramps if traders algos try and game duration.

Information Positive Feedback Loop

Many in the market,  we fear, are being hoodwinked by the flattening yield curve, however.  It’s purely the result of technicals and not economic fundamentals.

Nevertheless,  some still look to the badly distorted bond market as a signal of the health of the economy and act accordingly.   Such as delaying capital spending;  becoming more risk averse;  and cutting back on consumption, for example.

A flatter yeld curve also makes bank lending less profitable.

This could thus lead to what George Soros calls “reflexivity” where the negative, but false, signal from the bond market actually causes an economic slowdown or leads to a recession.   So much for efficient markets.

Recall the famous line of one prominent market strategist during the dark days of the great recession,

“ We’re in a depression. That is what the bond market is telling us.”

Or the ubiquitous,  “what is the bond market telling us?”    Come on, man!

The Fed Needs To Start Selling Longer Dated Securities

It would, therefore,  behoove the Fed to sell some of its longer dated Treasury holdings to steepen the yield curve.

The follwing table shows the Federal Reserve’s holdings of U.S. Treasury securites and the total Treasury outstandings for each year.  This table does not include T-Bills.

If the Fed were to just let its balance sheet “run off” — that is not rollover maturing notes and bonds — it would cause additional pressure on short-term interest rates even as policy rates are rising.  It could also  potentially invert or further disort the front-end of the yield curve and destablize the money markets.

Looking at the data in 2018 and 2019  large maturities are coming due.   Rolling a portion of these maturities and selling longer-dated securities would probably cause less disruption in the market and be a more optimal strategy of reducing the Fed balance sheet.

Notes and Bonds_June13

Announcement Effect

Just announcing the fact the Fed was contemplating such a strategy of unloading longer dated Treasuries first would cause the yield curve to steepen.   The market would  begin to front run the Fed.  Bill Gross & Co. would kick into action and “sell what the Fed wants to sell.”

And because there are so relatively few Treasuries outstanding with maturities longer than 10-years,  it is unlikely it would cause a bond market debacle, which many believe is coming.  The total stock of Treasury securities with maturities longer than 10-years is smaller than the combined market capitalization of just Apple, Google, and Amazon, for example.

If bonds become too oversold, the Fed could easily engineer a short squeeze to bring the yield curve back to where it desires.

Recall, the Fed losing control of the yield curve prior to the financial crisis to foreign central banks recyling capital flows back into the U.S. is what Alan Greenspan singles out as the major cause of the housing bubble.   The Fed moved the funds rate up 425 bps and the 10-year and mortgage rates barely budged.

During the 2004-07 tightening cycle, the era of the Greenspan bond market conundrum, for example, the 10-year yield managed to rise only a maximum of 64 bps during the entire cycle from a beginning yield of 4.62 percent to a cycle high yield of 5.26 percent. This as Greenspan raised the fed funds rate by 4.25 percent, from 1.0 percent to 5.25 percent.  – GMM, March 2017


The risk is that foreigners begin to sell.  But where will they go?

Spanish 10-years at 1.43 percent?  German 10-year bunds at 0.266 percent?  How about a 10-year Japanese JGB at 0.067 percent?    In fact,  low foreign yields and the ensuing portfolio effect is keeping the U.S. 10-year note well anchored below 2.60 percent and another factor distorting the yield curve.

Credit and Equity Markets

That is where there we could have some short-term problems and overshooting.   But our sense, many are waiting to pounce on a sell-off in the spread and equity markets.   Too many pensions are underfunded and too many seniors are yield strarved.

Having some dry powder makes sense.    It’s coming and you will have to act fast.


A sustained spike in inflation?

Tilt!  Game over, comrades.

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Secret Weapon's picture

The system is dead.  Still twitching, but dead.  Get ready for the Reset.

medium giraffe's picture

All they have is Ctrl+P, just life support.  There isn't a damned thing anyone can do to fix it.

knukles's picture

Lemme see here.  Since all the manipulations to date haven't worked, now they should manipulate long rates higher in order to ummm ah  we ah    it will uh   ummmph
Sounds solid                           Fucktards

auricle's picture

Well if we are so flush with fiat these days, why the need to raise the debt ceiling? Magic Janet is going to school the world on how to liquidate $4.5T in debt from a system that requires exponential debt growth. 

-Pipe Dream

medium giraffe's picture

All whilst she raises servicing costs on the principal.  Janet likes to play on legendary mode.

Cognitive Dissonance's picture

Don't you mean her legacy mode?

Just askin'

medium giraffe's picture

Lol coggy.  She's trying to run Greenspan Lotus 1-2-3 on an iBenny.

yogibear's picture

It's dead FRED (Federal Reserve Economic Data).

Sy Kloine Bee's picture

I don't know about selling it yet, but at least they're talking about capping reinvestment...

IENTJ's picture

BARON MUNCHAUSSEN (Steve Mnuchin) will bundle ALL fo these "assets" into 100 and 200 year MOON BONDS!

montresor's picture

Well the long end is the Alamo.. That's where everyone has been trying to hide... If they blow out the long end, that's it.. It's the end of any yield at all.. Which said differently, is hyper monetary inflation..  It's the end of all interest rate/yield dependent industries, like insurance, pensions, public finance, and commercial banking..

This is it... they're here...

gregga777's picture

"Recall, the Fed losing control of the yield curve prior to the financial crisis to foreign central banks recyling capital flows back into the U.S. is what Alan Greenspan singles out as the major cause of the housing bubble."


Alan Greespan and the Goldman Sachs Feral Reserve System deliberately engineered Housing Bubble 1.0 just like Benjamin Shalom Bernanke and Janet Yellen have deliberately engineered Housing Bubble 2.0 and the Every Asset Bubble 1.0.


Remember, the motto of the Goldman Sachs Feral Reserve System is:


"We steal from those least able to afford it and give to those who least deserve it."

Too-Big-to-Bail's picture

I've learned if enough people buy the illusion, then it really isn't an illusion.... yet!

Seasmoke's picture

Karen Hudes says this system has already been put to pasture. Reset on its way.

FreeNewEnergy's picture

With their caps at $10 billion a month, it will take them 30 years to offload $3.6 trillion.

I'll be dead by then, maybe. The good news is that Yellen almost certainly will be. Must be nice to make decisions which will outlive you and affect future generations and not give a fucking shit.

As mediaum giraffe said above,

"There isn't a damned thing anyone can do to fix it."

I'm down wiht that.

Dr. Engali's picture

The risk is that foreigners begin to sell. But where will they go?

Spanish 10-years at 1.43 percent? German 10-year bunds at 0.266 percent? How about a 10-year Japanese JGB at 0.067 percent? In fact, low foreign yields and the ensuing portfolio effect is keeping the U.S. 10-year note well anchored below 2.60 percent and another factor distorting the yield curve."

That statement right there says everything that you need to know. There is no reason to be raising rates unless they want to bring it all crashing down. There is plenty of demand for U.S treasuries because there is no where else to go for yield.

Schmuck Raker's picture

Central banks can SELL???

Dragon HAwk's picture

Must keep Illusion alive that they are not buying all of their own debt.

Cozy Vanilla Sugar's picture

How can this GMM outfit say the move down in the 10-year is purely a result of low tradable float (because Fed and foreign CBs/SWFs own so much of it)? Does a stock price move purely on technicals if 2/3 of the float is owned by a private equity firm?

Could it not be that the Fed raising short rates into economic weakness and the most levered US economy in history has led to a rational expectation of more weakness and lower rates going forward?

saveUSsavers's picture

What the fuck are these Fed cockroaches going to sell?


MR166's picture

When the US doubles it's national debt every 8 years and the fed is the buyer of last resort for both treasures and the US stock market how can they sell anything at all and who will they sell it to?

If they don't prop up the stock market the entire US pension system fails and the few remaining taxpayers have to pick up the bill.

I don't know about gold, bitcoins and silver but 5.56 ammo should be worth something in the very near future.

Bam_Man's picture

The Fed will never sell ANYTHING. EVER.

They will, at best, hold to maturity, and not re-invest - for a while.

And then there will be another QE program, and another and another....

This guy is a clueless MORON.

wisehiney's picture

Back in the day, they all called him "Shilly".

I would have added "Fucker".

R2U2's picture

 "It would, therefore,  behoove the Fed to sell some of its longer dated Treasury holdings to steepen the yield curve."

The yield curve should be the RESULT of a strong demand for money, not the cause.

GunnerySgtHartman's picture

Well stated sir.  You've described very succinctly how f*cked up the whole situation is.

gold rubeberg's picture

R2U2 I would have upvoted that ten times if I could. Imagine that ... the price of credit being set in the free market ... what a concept!

wisehiney's picture

Hello Author.

I would have delved deep into this article if you had written about:

"Why My Mama Made An Ignorant Child"

taketheredpill's picture
More TWIST might flatten the curve.  But if you're selling Long TReasuries to the Banks in REVERSE/QE the outcome isn't certain. Recall QE involved the Fed Buying Treasuries but Yields mostly rose.  Once QE was halted (not reversed) Yields fell.  I always thought this was simple asset allocation shifts, selling Treasuries to buy Equities/Corp during QE and vice versa. So if Bonds sold off during QE, rallied when QE was halted, what will happen when QE is Tapered?? 
gold rubeberg's picture

At the rate the Treasury is borrowing, it otta be able to sell enough longer dated paper. The problem is the foreign central banks and their bond buying. Even at these low yields, USTs look pretty good next to bunds and JGBs sporting yields near or below zero. Ain't globalism great?

nicktd's picture

short end yields went up during Lehman crises. Investers saw higher risk. Only when Benerke and bailout occured did backing of US bonds saw yields decline so that investers can front run.