What We Learned About Treasuries on the Night of April 8

your money back, You want some certainty. People don't buy it because it's moving around a lot on a day to day basis. And yeah, that's exactly what we saw happen in April post Trump's Liberation Day on April second, So we should talk about.

looking for cash. We need answers for what happened the night of April eighth.

Ira Jersey. He is, of course, chief Global Interest rate strategist for Bloomberg Intelligence, and I'm so glad we can finally have him on to talk about everything that's been happening. Iira, thank you so much for coming on on lots.

questions about the financial world back then. I think this period is a little bit different in that we're talking about and you've talked about this on the show already over the last few weeks. This is a bit different because you're talking about real economy issues as opposed to financial economy issues. And because of that, people are wondering, like, is there going to be a new world order? What does it mean when you get you know, thirty basis point spikes in the ten year yield on you know,

just one tweet. Does that mean that the dollar is no longer going to be the reserve currency? These are the questions that we continually get and it's difficult to say at this point because we don't know what the endgame is. But yeah, like you said, Tracy, there's absolutely no lack of things to talk about.

the path would be if they didn't do anything. In two thousand and eight, we knew that like, look, if TARP didn't pass, what might have happened to the banking sector At the time, you just had Leman go under. You just had Fanny and Freddie go under. So and yes, there was some policy response, but it wasn't enough, Like the FED alone wasn't enough to get us out of

that particular situation. And I think here the issue that we have today is there is and we always use the term uncertainty, but I think we have to because we don't know what the endgame ultimately is, right. We don't know is is this the administration's way of getting people to the table for things like defense burden sharing. Is this the way that for them to get to

the table to isolate China? Is this the administration's way of basically saying that, Hey, we don't know how to cut the deficit, so let's focus on international because we can do that. And that's in the president's purview as opposed to something that Congress has to do. So I think that there is a lot of right now uncertainty. And I think the moves in the treasury market kind of show the fragility of liquidity in the treasury market. And there's a lot of reasons for that, and we

can get wonky. And I've talked about this for over a dozen years since the Basil capital rule regulations went into effect. But there are a lot of reasons to think that we're going to continue to see these bouts of volatility in the treasury market because of structural changes, and when those structural changes come out like they did the last few weeks, you do see these extreme volatility events like we did on the seventh of April, Like we did on the ninth of April.

What did I say, macropod multi strategy is blowing up? Yeah, pod is blowing up somewhere. And I feel like people start talking about the basis trade as soon as there's some fall event in US treasuries nowadays. But what are we discovering about the basis trade and its role in the sell off a few weeks ago in the aftermath and with some new numbers and information that's been coming out.

against cash if it was the treasury futures basis. I think that one of the reasons why many people focused on this early on was it was something that the Federal Reserve and some other policy makers were worried about because they are very highly levered trades. But they have

to be. But why were these trades created? So these trades are created because asset managers, in order to comply with some of their own liquidity rules, end up having a lot of cash on their balance sheet and to make up for their duration gap to be closer to the Bloomberg Aggregate Index or whatever their benchmark is, they go out and buy futures on top of that cash instead of buying an actual treasury security. What that means is, because it's a future, there has to be a seller

for every buyer of a futures contract. So that leaves others which has to be then levered investors or dealers short treasury futures. Now, if you're short of treasury future and you don't want to be short treasury future, you don't want to be short treasuries, what do you do? You have to hedge that somehow, And there's only realistically two ways that people hedge. One is you can buy a treasury or you can receive in an interest rate swap, and that's what we call an invoice spread. So it's

futures versus swaps is called an invoice spread. We can go back to the history of the nineteen eighties about how that got its name, but I think that's unimportant for this discussion. So what you did see during that period of time was not so much the treasury futures basis trade unwinding, but you saw the swap spread portion

of that trade unwinding. And that's one reason why everyone talked about the treasury futures basis, but it really if you looked at the price action, it was really the swap market that was moving around ten basis points at a clip, just on every single headline, every single tweet. And I think that that's more reflective of the leverage that was being unwound, was more in the over the

counter swap market as opposed to in the futures. Well, I was about say, future's pits is not really pits anymore, but.

swapspread wideners. So swapspreads have been negative even when we still have libor. So now we use something called SO for the secured overnight financing rate, which is basically the repurchase agreement market that's used as the underlying for these

interest rate swaps. It used to be libor. Even when it was libor, swap spreads in the long end especially were very negative, and the reason for that was the new regulations that went into effect again, both dot frank and some basle regulations, plus a very underappreciated part of the market, which is insurance company regulations, which are often

regulated by states, not by the federal government. So when states said, oh, you have to have a more diversified portfolio of credits within your general account for life insurance companies or p and C property and casualty insurers we call them p and C insurres, they go out and say, okay,

we want to buy thirty year single a corporate debt. Well, if you want to be diversified and be in one hundred different names, there's not one hundred names that your credit analysts are going to let you be in and allow you to buy that issue thirty year debt. So what happens is they end up having to buy ten year debt or even five year debt in some cases, and that leaves these insurance companies with this massive duration gap because they have long term liabilities. Right life insurance

contracts are very long term liabilities. They need to hedge that with having their own long term assets on their balance sheet, and that ten year corporate doesn't meet that need. So how then does an insurance company end up making up that duration gap? And the answer is they receive

an interest rate swaps because it's capital efficient. When you start an interest rate swap, your cost is zero as opposed to going out and buying a treasury or even buying a treasury strip, so as zero coupon long term treasury we call them treasury strips. They don't want to do that because it's not balance sheet efficient. So that's

kept swap spreads negative. But what kept swapsharp is even more negative, was the fact that banks couldn't own enough treasuries in order to kind of hedge their own short exposure to interest rate swap. So it's underappreciated how much bank and bank balance sheets really matter to the pricing of a lot of these trades and security.

and now they're being backstopped. And what I like about your explanation or your characterization is they're economic rationales for this trade because it often gets flattened into speculation and a casino. But various entities, whether it's the banks meeting their regulatory obligations, the insurance companies are meeting their regulatory obligations, there are real rationales for the existence of these markets rooted in economics.

And then there's liquidation. Someone has to meet a margin call somewhere, pay cash somewhere, and so they have to sell their low liquidity treasuries to get a cash or whatever.

dealer desks, and they're going to be constrained. So even if you only had a little tiny bit of selling right in terms of volume, if it was all one way at the same time, you probably had dealers that weren't willing to take on that exposure at that moment. And you'll notice on that day, like if you just do an inter date chart and do a GP on the tenure yield on the Bloomberg terminal.

and a long position. And then the market was still very volatile after that. And I think part of the reason it continued to be volatile was, besides the fact that we had all of the tweets on again off again tariff talk, is that people don't like to get in front of volatility. And the fact is when volatility is high, dealers tend to not only widen their bid offers, but they also pull back. And another I think underappreciated aspect of this too, and again I go back to

financial sector balance sheets. If you look at dealers, dealers were as long treasuries going into this as they've ever been, so they own more treasuries than ever in history. Now part of that is because the treasuring market is bigger, but a lot of these treasuries that they added they added within the last six months. So this wasn't like it wasn't like it turned on the dime, and it

wasn't very systemic. But the fact that there was a lot of cash already on dealers balance sheets and still is dealers are still very long cash bonds right now, and again there are short futures on the other side of that, It probably meant that they weren't able to take on a lot more supply without getting approvals. Right, you have to go to your risk manager and say, hey, we'd like to make markets here, but we're fall like

can we make markets? So there are a certain amount of regulatory arbitrage that you can't do today that you were able to do prior to the Basle three capital rules going into effect. It's what I call balance gad elasticity. Basically, dealers don't have the same type of balance sheet elasticity as they used to have prior to Basil two and a half in Basil three rules.

money investors. And this to me is actually like, this is the scenario that could be more worrying than a basis trade blow up, because like, okay, basis trades blow up, the FED can basically come in and do something pretty easily nowadays, and we're talking about a single levered trade that's based on arbitraging, like a very technical relationship that's blowing out, and so all of those positions are getting

changed very rapidly. But if we're talking about the collapse of a real money investment in US debt because of all this policy uncertainty and people wanting to I guess dedollarize their balance sheets, that seems much more existential to me. So what have you observed in the case of real money investors?

were selling. So this idea that you know, Joe brought up some one of the things that people were saying, that oh it's China selling.

have their portfolio run off. And you've seen China do this actually over the last ten years or so, reduce their portfolio in order to defend their currency. And they want to be able to do that very quickly without moving the market a lot. And in order to do that, you own short term debt. Now who does own the long term debt? And we put out a chart about this actually a couple of weeks ago, actually on the eighth and most foreigners who own the long end are

private investors. So these are portfolio investors. These are pension funds, insurance companies, and they own those because they can buy treasuries and even after currency hedging, pick up yield compared to their own home currency. So one of the perfect examples of that is Taiwan. So taiwan Es insurance companies will buy a lot of US debt, both corporates and treasuries, and if they hedge it back, they still pick up

yield compared to the Taiwanese dollar debt. So they like doing that trade, right, Why wouldn't you You pick up yield and you get US treasury risk instead of time on treasury risk. If you go to a central bank, they won't be doing that, right. They'll go out and they'll participate in three year auctions to your auctions. They'll buy T bills and let that roll off. So the price action that occurred during that period of time April seventh to April eleventh didn't react like one would expect.

If you had central banks who were massive sellers of treasuries, you would have expected to see the front end sell off. But no, the front end rallied right, So you saw lower yields in short term debt and higher yields and long term debt. I think part of that was an inflation trade. I think that a lot of people thought and did think. And I was up late some of those nights too, talking with clients in Asia and what you heard from many of them is, isn't all of

this just inflationary? Because what Donald Trump and his administration are doing is going to force us into recession or he's going to fire Powell. And if he thought does that, then interest rates are going to be too low, tariffs are going to keep inflation higher. So that all was a curve, and that's really the trade that you saw. You saw that twist deepening of the yield curve.

treasuries in that moment. But it still raises the question of the impetus for the selling by the marginal traders at the time, why they were selling in the first place, as opposed to buying safe haven asset, because that's often what you do when the stock market is selling. Is

it essential? And it sort of sounded like in your last answer that it was just a mini version of that twenty twenty two dynamic where if you have bad growth outcomes and sort of bad inflation outcomes, you sell stocks and treasuries at the same time.

So if there were people who were long treasuries in Asia at Asia hours, like let's say that it's a sovereign wealth fund or an asset manager in Hong Kong or Singapore who was long ten year treasuries and thirty year treasuries because they thought US was going to have a recession and we were going to have lower interest rates and all of that. And all of a sudden,

you hear everything coming out of New York. You wake up in the morning and you say, maybe I have too much risk on and then you try to take off some of that risk in a market that's not able to absorb that risk because dealer balance sheets are completely anelastic the price then has to move pretty dramatically,

and you've seen that over different periods of time. Look, the Treasury Department right now holds a conference every year that I attend very regularly, not every year, but probably two out of every three years about resilience of the treasury market. And that all stemmed from about ten years ago. We had the flash rally where US treasuries rallied fifty basis points in fifteen minutes on no news right on nothing. So why would that have happened. Well, it's because, well the rumor was.

the opposite of that. And as the treasury market's gotten bigger, keep in mind the treasury market's nearly thirty trillion dollars of marketable debt outstanding, of which about twenty three trillion dollars is coupon, so not te bills. I always take T bills out of this equation, by the way, because when people say, oh, there's this wall of debt that has to be refinanced this year, the fact is seven trillion of that or near seven trillion of that is treasury bills.

that need to be rolled over every year. Right There's you know, half a trillion dollars to a trillion dollars every year of coupons that mature need to be rolled over just about every quarter. So when you're in a situation like that and you're treasury dealer and you have to bid at these auctions, you have to save some room, and you can't always be full on treasuries, and you

don't want to get full on treasuries at midnight. If you're again like one of the bulch bracket banks and the overnight trader in Hong Kong, the last thing you want to do is get a tap on your shoulder from a risk manager and have that risk manager say to you, hey, you broke your budget. You know the

door's over there. So there's career risk involved in all of this as well, which I think is also a second thing that's underappreciated is just mentality of trading desks is meaningfully different than it was again before Basle, because risk managers run the market now, not traders, and I think that that's also something else that's underappreciated by a lot of people.

run of the mill selling of US treasury. So for instance, we had Japan's Ministry of Finance showing that private investors in the country sold like seventeen point five billion in long term bonds in the week this was ended April fourth. I actually needed to go and look at what the

week after happened. But even before then, Japan's private sellers they sold a bunch of US bonds, like literally right before early November when we had the election, And if we look at some of the commentary we've seen from analysts over the years, there's a lot of discussion of

a lack of structural demand for US treasuries, especially overseas. Right, Like, some of the foreign buyers that were buying US debt a decade or two decades or three decades ago just aren't buying as much of it as they used to talk to us about. Like the I guess long term outlook for US treasury demand, where is that going to be coming from? And how true is it that we have seen a bit of a rebalancing from foreign to domestic sources.

who's buying the riskier parts of the market. So ten years and thirty year debt, for example, you can buy a little bit of that and effectively buy a lot of risk the central banks have certainly been diversifying their portfolios, and I think that this makes a lot of sense. Right if you were a central bank and you said fifteen years ago, you said, oh, ninety plus percent of our foreign exchange reserves are all in US dollars, but we only do fifty percent of our business our trade

in the US dollar. We do a lot in euros, and we do a lot in yen, right, so we want to diversify our foreign exchange holdings. That's something that has been going on for better part of a decade, and in fact, aggregate ownership of US treasuries has actually kind of been flatlined, and as a share of the market, it's gone way down now. But who's replaced that we have to keep it To keep this in mind too, and this is to your point, Tracy, I think, is

like who's going to be the incremental buyer? Because the Fed now owns a lot more treasuries than they did, right, because they did quantitative ease for the better part of three years and they purchased a significant share of the market. Now they don't own an unusually high share of the market,

but in notional terms, it's a very large share. So the FED usually owns around twenty percent of the treasury market and has basically since the nineteen sixties, Right, It's always owned about twenty percent of the market, But now the market is so massive, and they were really a very large non economic buyer of treasuries that they're hard

to replace in the market without their being additional. You know, I don't love the concept of term premium the way that we measure it, but there is term premium right in the market, and at some point, term premium has to go up if you are not sure where demand is going to come from from these longer duration assets, and by doing what President Trump's doing, there is a

fear out there. And I've spoken to a lot of investors both here in the US and overseas about is there going to be significant demand for treasuries if, say to Trump administration's able to get our trade better in line the buying of treasuries that you saw back in the early two thousands and right after the global financial crisis that also coincided with a massive increase to the US current account deficit, So we were effectively exporting a

whole lot of dollars, and as we're exporting those dollars, the financial account has to balance, So one of two things has to happen. Either people sell the dollar and then buy their home currency. Therefore their own currency winds up appreciating versus a dollar, and that makes them less competitive, and I think that's kind of what President Trump seems to want to do at least as one of the outcomes of all of this tariff negotiation and trade negotiation. Or you have to go out and buy a US

dollar denominated asset. Now that could be a hard asset, it could be corporates, it could be but treasuries are the thing that most countries want to own because it's liquid. You buy short term treasuries and you kind of know you're going to get your money back. You also know that you could replace them very easily because there's auctions every single month. So there's a whole reason why you

would want to own treasuries. When the current account bounce is massive, go back and just you know, you can go on the Bloomberg terminal or go on go on to our Bloomberg Intelligence dashboard bi rates and you can look at just how much foreigners bought of US debt as the current account deficit went up as a current account deficit got better. In the second half of the twenty teens, you saw that there was significant slowing of what foreigners were buying of US dollars because they just

didn't need to. They had other alternatives and they and the current account deficit was significantly lower.

to sell. But just on the my last question is, you know, Tracy and I are on opposite sides of this, the term premium question. I am yet to convinced be that it's a useful concept. I like, the old curve is the old curve, it's the what.

yield curve generally is upward sloping. Right, not always, but generally it's upward sloping because of the uncertainty about the future path of interest rates, and there's you know, there is probably a little tiny bit of credit premium in that term premium, but really it's a risk premium for the unknown going forward. So term premium exists. I think I don't love some of the models and the way

that we actually try to determine term premium. So the FED has several different models, like the Adrian Crump model, for example, which attempt to quantify what the term premium is at any given moment. I like things that you can trade, because that's our job. And the problem is that if you tried to use the fed's models for term premium and said, oh, this looks like it's too steep or too flat, and you did those trades, you'd lose more than half the time. So they're not particularly

good predictors of is the market rich or cheap? And as investors, that's our job. So they might be interesting on an academic basis, but if I can't trade it, I don't care about it. And that's why generally speaking, I look at the yield curve. I do have my own. It's more of a fair value model for the yield curve as opposed to a term premium model, but it

has a similar effect. But you can determine are we rich or cheap given the variety of outcomes from both the FED reserve and also supply and other inputs that we use for those models.

and then we saw the big market crash. But you know, looking back on it, it kind of feels like bonds were the pressure point for him when it comes to ratcheting back some of the tariff tenshion. What's the role of the bond market, I guess when it comes to influencing the new Trump administration.

that's what we're trying to do. Of course, we've sold off since then in March, part because of this risk premium that we're talking about, as well as some of the structural issues that we discussed earlier in the show.

I think it matters because, look, the fact is, even if the President is able to find half a trillion dollars in savings and that sounds so weird to say half a tree brillion and still not being big enough to kind of matter, you're still going to have trillion dollar deficits that need to be funded, not to mention rolling over the existing debt that's going to be maturing. And as that occurs, you know, you want to get

the lowest borrowing costs for the taxpayer. So I understand that President Trump really would like to see lower tenure yields. But one way to do that is to actually issue less ten year bonds, right, that's one way, But you can't do that unless you really significantly decrease the deficit and actually even maybe balance the budget, right, because you're

going to be issuing more and more. In fact, we're coming out with our Treasury Funding report probably right around the time that a lot of people listening to this on. It'll be on the twenty fifth of April, and next Wednesday, the Treasury Department will decide and Scott Bessen and his appointees will decide how they're going to fund the deficit. And they're still going to be nearly a two trillion dollar deficit this year, and he's going to have to

issue ten year treasuries. So I think that if there's not demand from overseas, investors lose faith in the US government and its ability to continue to finance the debt. That has to worry at any administration, regardless of whether it's President Trump or President Biden or whomever.

structural retreat in receives demand. And if we think about what Trump is trying to do right now in terms of rebalancing global trade and reducing the US trade deficit, it does seem like one of the outcomes of that is structurally less demand for US treasury.

bottom of the recent range in the dollar. And so one way that that sort of retreat from America trade expresses itself, in my mind, is not necessarily through the price of the curve or anything, but just the fact that like relative to the rest of the world, the dollar is less appealing. On one other thing, I just want to get in on the question of the treasury

market's influence on the government. I certainly one hundred percent agree with you that the government clearly while it's lower and it doesn't like higher yields for all kinds of it. They've said it, they've said it's God best and has said it. The only reason I don't like the term dollar vigilantes is I bon bond vigilantes is that it prescribes a level of sort of like agency that I don't think is helpful. O.

are doing. I would like it if there was like an actual bond vigilante who you could, like, you know, you could flash one of those like Batman signals in the sky for the bond vigilante and they would all come out and start selling you as treasuries and affect change in certain policies that would be interesting anyway, shall we leave it there?