Macro Pillars @MacroPillars - Twitter Profile

10 days ago

The market has been working through and digesting the nuances from Chairman Warsh’s FOMC meeting on 29 July, with a directive from Warsh to consider a broader set of inflation measures than PCE alone. The Dallas Fed’s 12-month trimmed-mean PCE measure printed at 2.2% the following day, quite close to the Fed’s 2% target. If the FOMC is going to place greater weight on lower measures of underlying inflation, such as the trimmed-mean PCE measure, which has been running well below headline and core PCE, then the logical market response is a weaker dollar and lower front-end rates relative to what had been positioned. This has become a focus for the market and helped spark a wave of dollar weakness into the Bank of Japan intervention. The renewed and potentially increasing use of the FIMA facility allows foreign governments to raise dollars against their Treasury holdings rather than sell them, cushioning the impact that intervention could otherwise have on US bond yields, an obvious choice for Bessent. The Treasury secretary has encouraged the Federal Reserve to consider increasing the size of the FIMA facility, while Finance Minister Katayama has indicated that Japan intends to use it again in the future. This, combined with one of the steepest curves in the world now beginning to flatten from the front end, as hedge funds and speculators are historically short the yen, is material for prolonged strength in Japan’s currency. Scott Bessent said at the beginning of the week that policy will need to follow the intervention and that the United States would not have joined the intervention if it were not optimistic about Japan’s policies. Provided the curve in Japan continues to flatten from the front end, the FIMA facility is used more frequently by foreign monetary authorities and the Bank of Japan continues raising its policy rate, which we believe may be increasingly likely following Bessent’s commentary, the jig could be up for the Yen shorts in the medium term. The above must then be combined with last night’s Quarterly Refunding Announcement. There was no change to nominal coupon or FRN auction sizes, consistent with expectations that any meaningful increases have been pushed further out. In fact, the key change was that Treasury adjusted its language from evaluating potential future increases in coupon and FRN auction sizes to evaluating potential future changes. That may be deliberate at this current juncture and could place further pressure on the dollar. It also leaves open the option of shortening duration rather than simply increasing coupons, while Treasury continues to fund seasonal requirements through bills and cash-management bills. Treasury maintained coupon sizes for at least the next several quarters and indicated that bill issuance will increase again across the curve in October. As critical as Scott Bessent was of previous Treasury secretaries before his appointment, it now appears that he is doubling down on the Yellen experiment. Increasing coupons would place additional pressure on the long end, and that is clearly something Bessent does not want. At some point, however, he will need to move towards coupons due to the sheer size of the maturity wall and the government’s funding requirements. He cannot continue funding everything through the front end indefinitely without increasing refinancing risk. Scott Bessent and Chairman Warsh are clearly working broadly in unison and, from our current read, appear even more dovish than the previous administration. The purpose, into the midterms, appears to be to keep the market afloat. Liquidity has been tightening; however, due to the fall in the MOVE Index this week, conditions have eased over the course of the week, with our liquidity measure incorporating MOVE now sitting at positive 13%. As we head into Friday night’s payrolls, Bessent has kept the funding concentrated in the shorter end, which is liquidity-positive relative to the alternative. Since Warsh spoke, the market rushed into a bear-steepener trade and may now be caught off guard if issuance continues to be concentrated towards the shorter end and the MOVE Index continues to fall. Chart - Japanese 30s-2s Yield Curve - Bear Flattener

MacroPillars's tweet photo. The market has been working through and digesting the nuances from Chairman Warsh’s FOMC meeting on 29 July, with a directive from Warsh to consider a broader set of inflation measures than PCE alone. The Dallas Fed’s 12-month trimmed-mean PCE measure printed at 2.2% the following day, quite close to the Fed’s 2% target.

If the FOMC is going to place greater weight on lower measures of underlying inflation, such as the trimmed-mean PCE measure, which has been running well below headline and core PCE, then the logical market response is a weaker dollar and lower front-end rates relative to what had been positioned. This has become a focus for the market and helped spark a wave of dollar weakness into the Bank of Japan intervention. The renewed and potentially increasing use of the FIMA facility allows foreign governments to raise dollars against their Treasury holdings rather than sell them, cushioning the impact that intervention could otherwise have on US bond yields, an obvious choice for Bessent.

The Treasury secretary has encouraged the Federal Reserve to consider increasing the size of the FIMA facility, while Finance Minister Katayama has indicated that Japan intends to use it again in the future. This, combined with one of the steepest curves in the world now beginning to flatten from the front end, as hedge funds and speculators are historically short the yen, is material for prolonged strength in Japan’s currency.

Scott Bessent said at the beginning of the week that policy will need to follow the intervention and that the United States would not have joined the intervention if it were not optimistic about Japan’s policies.

Provided the curve in Japan continues to flatten from the front end, the FIMA facility is used more frequently by foreign monetary authorities and the Bank of Japan continues raising its policy rate, which we believe may be increasingly likely following Bessent’s commentary, the jig could be up for the Yen shorts in the medium term.

The above must then be combined with last night’s Quarterly Refunding Announcement. There was no change to nominal coupon or FRN auction sizes, consistent with expectations that any meaningful increases have been pushed further out.

In fact, the key change was that Treasury adjusted its language from evaluating potential future increases in coupon and FRN auction sizes to evaluating potential future changes.

That may be deliberate at this current juncture and could place further pressure on the dollar. It also leaves open the option of shortening duration rather than simply increasing coupons, while Treasury continues to fund seasonal requirements through bills and cash-management bills. Treasury maintained coupon sizes for at least the next several quarters and indicated that bill issuance will increase again across the curve in October.

As critical as Scott Bessent was of previous Treasury secretaries before his appointment, it now appears that he is doubling down on the Yellen experiment. Increasing coupons would place additional pressure on the long end, and that is clearly something Bessent does not want. At some point, however, he will need to move towards coupons due to the sheer size of the maturity wall and the government’s funding requirements. He cannot continue funding everything through the front end indefinitely without increasing refinancing risk.

Scott Bessent and Chairman Warsh are clearly working broadly in unison and, from our current read, appear even more dovish than the previous administration. The purpose, into the midterms, appears to be to keep the market afloat. Liquidity has been tightening; however, due to the fall in the MOVE Index this week, conditions have eased over the course of the week, with our liquidity measure incorporating MOVE now sitting at positive 13%.

As we head into Friday night’s payrolls, Bessent has kept the funding concentrated in the shorter end, which is liquidity-positive relative to the alternative. Since Warsh spoke, the market rushed into a bear-steepener trade and may now be caught off guard if issuance continues to be concentrated towards the shorter end and the MOVE Index continues to fall.

Chart - Japanese 30s-2s Yield Curve - Bear Flattener

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