How U.S. Treasury Is Fighting The Fed | Nouriel Roubini & Stephen Miran on $800B “Stealth QE”
Introduction
Forward guidance is sponsored by Vanek, a global leader in Asset Management since 1955.
The episode focuses on the US Treasury’s actions and their potential impact on the Federal Reserve’s functions.
Guests include Steven Moran, senior strategist at Hudson Bay Capital, and Norel Rabini, senior economic adviser to Hudson Bay Capital.
Activist Treasury Issuance (ATI)
The paper titled ‘ATI: Activist Treasury Issuance and the Tug of War over Monetary Policy’ is discussed.
ATI refers to the Treasury issuing a higher ratio of short-term bills compared to long-term debt, deviating from standard guidelines.
This action is likened to a form of backdoor quantitative easing, reducing long-term Treasury supply and lowering yields.
Impact on Monetary Policy
The Federal Reserve has been tightening monetary policy to cool the economy and reduce inflation.
The Treasury’s actions are seen as counteracting the Fed’s efforts, effectively easing financial conditions.
Empirical estimates suggest this unconventional fiscal policy is equivalent to a 100 basis point cut in the Fed funds rate.
Political vs. Independent Monetary Policy
The Treasury is part of the executive branch and influenced by political priorities, unlike the independent Federal Reserve.
The paper argues that the Treasury’s actions blur the line between politically driven and independent monetary policy.
This sets a potentially dangerous precedent by allowing political considerations to influence monetary policy.
Mechanics of Treasury Issuance
The Treasury can issue short-term or long-term debt to finance deficits.
Issuing more short-term debt reduces the supply of long-term Treasuries, increasing their price and lowering yields.
This is comparable to the Federal Reserve’s quantitative easing, which increases demand for Treasuries to lower yields.
Substitutes for Money
Treasury bills (short-term debt) are similar to money in terms of credit and interest rate risk.
Bills are treated similarly to bank reserves from a regulatory perspective and are close substitutes for money.
Issuing more bills has minimal impact, but issuing more long-term debt (coupons) can significantly affect financial conditions.
Introduction to Capital Ratios and Interest on Reserves
Capital ratios and interest on reserves have made treasury bills similar to money.
The Federal Reserve (FED) started paying interest on reserve balances to banks.
Impact of Treasury Issuance on Market Risk
Issuing more intermediate and long-term debt increases market interest rate risk.
Markets have a fixed appetite for risk; more interest rate risk reduces the ability to absorb other risks like credit, equity, and commodity risks.
Quantitative Easing (QE) Mechanism
QE works by the FED buying bonds, increasing their price, and pushing investors to buy riskier assets.
This process, known as the portfolio balance channel, increases asset prices and stimulates economic activity.
Activist Treasury Issuance (ATI) Mechanism
ATI reduces the creation of interest rate risk at the source by issuing more bills and less long-term debt.
This has a similar effect to QE by making interest rate risk scarcer and pushing up asset prices.
Comparison of QE and ATI
Both QE and ATI manipulate the amount of interest rate risk and money-like instruments in the market.
ATI is effectively a stealth QE program implemented by the Treasury instead of the FED.
Economic Impact of ATI
ATI is equivalent to a 100 basis points cut in the FED funds rate.
This has kept the economy in a ‘no landing’ scenario with growth and sticky inflation.
Mechanics of Treasury Bills and Coupon Debt
Treasury bills are very money-like and have little economic impact when swapped with bank reserves.
Coupon debt bears interest rate risk and has significant economic consequences when swapped with money-like instruments.
Conclusion on ATI and QE
Both ATI and QE work by manipulating interest rate risk and pushing up asset prices.
ATI limits the creation of interest rate risk at the source, while QE buys it from the market.
Introduction and Initial Questions
Discussion on the impact of 800billionofactivistTreasuryissuance(ATI)versus800billionofactivistTreasuryissuance(ATI)versus800 billion of quantitative easing (QE) from the Federal Reserve.
Both ATI and QE have similar impacts on the economy, particularly on interest rates and financial conditions.
Impact of ATI and QE
ATI reduces the supply of long-duration assets, while QE increases demand for these assets.
Both actions result in a reduction of interest rate risk and have similar effects on the yield curve.
Economic Conditions and Predictions
Concerns about a hard landing due to Fed rate hikes were alleviated by positive supply shocks.
Recent trends show robust growth and persistent core inflation, leading to a ‘no landing’ scenario.
Role of Activist Treasury Issuance
ATI maintained easier financial conditions, stimulating asset prices and preventing a hard landing.
Without ATI, the economy might have slowed more, potentially leading to a short and shallow recession.
Treasury’s Strategic Decisions
Treasury officials, many of whom are former Fed officials, are well-versed in QE and forward guidance.
Treasury’s recent decisions on debt issuance are seen as sophisticated and strategically timed around elections.
Treasury’s Debt Issuance Strategy
Treasury’s role is to finance the deficit, not determine its size.
Decisions on debt issuance (short-term vs. long-term) are influenced by market demand and regulatory changes.
Historical Context and Policy Deviations
Treasury typically issues 15-20% of debt in bills, with the rest in intermediate and long-term securities.
Regulatory changes post-2008 financial crisis and during the pandemic influenced Treasury’s issuance strategy.
Regulatory Impact on Treasury Bills
Regulatory reforms led to increased demand for Treasury bills, particularly from money market funds.
Treasury adjusted its issuance strategy to accommodate this demand, increasing the target share of bills.
Introduction and Historical Context
In 2008 and 2010, post-Great Financial Crisis, there was a regulatory drive to increase the share of treasury bills.
The target share of bills in treasury issuance was lifted from 10% to 15% in 2015-2016.
During the 2020 pandemic, the target was further increased from 15% to 20% to provide more flexibility for emergency issuance.
Pandemic and Emergency Issuance
The increase in bill issuance during emergencies is due to the need for fast, liquid funding.
Raising taxes or issuing long-term bonds is not practical during sudden financing spikes.
Historical data shows spikes in bill issuance during financial crises and the pandemic.
Current Treasury Issuance Practices
Recent treasury issuance practices have deviated from historical norms, with a significant increase in bill issuance.
This deviation is seen as inappropriate given the current economic conditions, such as low unemployment and high stock market performance.
The current level of bill issuance is compared to crisis periods like 2008 and 2020, despite the absence of a similar crisis.
Impact on Economy and Policy
A small change in the share of bills can lead to a significant impact on the economy, potentially causing a trillion-dollar shift.
Quantitative easing programs are usually a few percent of GDP, highlighting the significant effect of treasury issuance changes.
Political and Policy Implications
There is a risk of political manipulation of the economy through treasury issuance, regardless of the party in power.
Historically, there has been a separation between monetary and fiscal policy to maintain long-term credibility and achieve inflation targets.
Recent practices blur the lines between monetary and fiscal policy, which could lead to long-term risks and undermine central bank independence.
Conclusion and Recommendations
Activist treasury issuance should be limited to genuine crises and not used during periods of economic stability.
Maintaining the independence of monetary policy from fiscal policy is crucial for long-term economic stability.
Both political parties have incentives to manipulate economic conditions, but such practices should be avoided to prevent long-term negative consequences.
Monetary and Fiscal Policy Interference
Political influence on monetary policy is a risk regardless of the party in power.
Trump attempted to influence the Federal Reserve to cut rates.
Central banks should remain independent to avoid political biases.
Current practices blur the lines between monetary and fiscal policy, posing long-term risks.
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US Treasury and Economic Stimulus
The US Treasury’s increasing Bill share is stimulative but may raise inflation.
Both political parties may become dependent on this practice, fearing market reactions if stopped.
Crowding out theory suggests government spending can reduce private sector investment.
Crowding Out Theory
Crowding out occurs when government spending leads to higher long-term interest rates, reducing private sector investment.
Excessive budget deficits can crowd out private sector economic activity and growth.
Public spending on infrastructure can be beneficial if it yields higher returns than borrowing costs.
US Fiscal Policy and Global Reserve Currency
The US benefits from being the global reserve currency, allowing it to run larger deficits.
Persistent large deficits pose long-term risks, potentially leading to severe market shocks.
Other countries with reckless fiscal policies face immediate market discipline, unlike the US.
Central Bank Independence and Inflation
Central bank independence is crucial to avoid excessive economic stimulus and inflation.
Politically motivated stimulus can lead to permanently higher inflation and interest rates.
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