Class 11: The U.S. Treasury Market Financial Markets, Spring 2020, SAIF Jun Pan Shanghai Advanced Institute of Finance (SAIF) Shanghai Jiao Tong University April 22, 2020 Financial Markets, Spring 2020, SAIF Class 11: The U.S. Treasury Market Jun Pan 1 / 27
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Class 11: The U.S. Treasury MarketFinancial Markets, Spring 2020, SAIF
Jun Pan
Shanghai Advanced Institute of Finance (SAIF)Shanghai Jiao Tong University
April 22, 2020
Financial Markets, Spring 2020, SAIF Class 11: The U.S. Treasury Market Jun Pan 1 / 27
Outline
The US Treasury (UST) market is unique:▶ The most credit-worthy, essentially free of default risk.▶ Large amount outstanding, highly liquid.▶ Supported by well developed repo and derivatives markets.
UST provides the most important benchmark curve:▶ The reference curve for cost of funds at different borrowing horizons.▶ Price discovery about inflation and macroeconomic fundamentals happens here.▶ Information on US monetary policy also happens here.
UST has also become politically charged:▶ Three rounds of quantitative easing after 2008 and the current infinite QE.▶ Large foreign holdings because of the reserve currency status of US dollar.▶ Financing the large and ever growing deficits of the US government.
Financial Markets, Spring 2020, SAIF Class 11: The U.S. Treasury Market Jun Pan 2 / 27
The Fixed Income Market with UST at its Core
Financial Markets, Spring 2020, SAIF Class 11: The U.S. Treasury Market Jun Pan 3 / 27
Ratios of UST to GDP
US Treasuries to GPD (%)
1960 1970 1980 1990 2000 2010 20200
10
20
30
40
50
60
70
80
US Treasuries MarketableUS Treasury Bills
US Public Debt $23.41T USD.US Treasuries $16.89T USD:
Japan 1211.7China, Mainland 1078.6United Kingdom 372.7Brazil 283.3Ireland 271.4Luxembourg 255.2Switzerland 238.1China, Hong Kong 229.6Cayman Islands 216.1
Financial Markets, Spring 2020, SAIF Class 11: The U.S. Treasury Market Jun Pan 7 / 27
Monthly Net Purchases of US Treasury Securities by China (USD Billion)
Financial Markets, Spring 2020, SAIF Class 11: The U.S. Treasury Market Jun Pan 8 / 27
Sharp Drop in Foreign Holdings of UST Amidst Global USD Shortage
Jan Feb Mar Apr May2020
2.84
2.86
2.88
2.9
2.92
2.94
2.96
2.98
3
3.02
0.5
1
1.5
2UST Custody Holdings (Trillion USD)
UST Custody HoldingsUST 10Y Yield (right)
Amidst global dollar shortage,foreign institutions sold USTto raise USD cash.FIMA Repo Facility: FIMAaccount holders can use USTheld at Fed as collateral toborrow USD cash.Announced: March 31.Effective: April 6.
Financial Markets, Spring 2020, SAIF Class 11: The U.S. Treasury Market Jun Pan 9 / 27
FX Reserves Held in Gold vs UST
Jan 2017 Jan 2018 Jan 2019 Jan 20200.9
0.95
1
1.05
1.1
1.15
1.2
1.25
1.3
2.8
2.85
2.9
2.95
3
3.05
3.1
3.15
3.2Global FX Reserves (USD Trillion)
2.844
Held in Gold (left)Held in UST
Jan 2017 Jan 2018 Jan 2019 Jan 2020815
820
825
830
835
840
845
850
855
2.8
2.85
2.9
2.95
3
3.05
3.1
3.15
3.2Global FX Reserves
2.844
Held in Gold (million ounce)Held in UST (USD trillion)
Financial Markets, Spring 2020, SAIF Class 11: The U.S. Treasury Market Jun Pan 10 / 27
Financial Markets, Spring 2020, SAIF Class 11: The U.S. Treasury Market Jun Pan 12 / 27
Monetary Policy and the Yield Curve
The Fed controls the short-end of the yield curve:▶ FOMC meets every six weeks to set the Fed funds target rate.▶ The Fed funds market: depository institutions lend reserve balances to one
another overnight.▶ The Fed uses open market operations to adjust the supply of reserve balances
so as to keep the fed funds rate around the target established by the FOMC.Fed traditionally does not control the long-end of the yield curve, but
▶ Since late 2008, the Fed did three rounds of QE.▶ Since March 2020, the Fed commits to infinite QE.
Absent of the Fed, the fundamental drivers of the long-term interest rates:▶ Inflation expectations.▶ Long-term economic growth.
Financial Markets, Spring 2020, SAIF Class 11: The U.S. Treasury Market Jun Pan 13 / 27
Fed Funds Target Rate, Yield Curve, and Business Cycle
In buying Treasury securities, the ultimate goal was to precipitate a broad reductionin the cost of credit (e.g., rates on mortgage and corporate bonds).Our purchases of hundreds of billions of dollars of securities were probably the mostimportant and definitely the most controversial tool we would employ.
– Ben Bernanke in The Courage to Act.
Financial Markets, Spring 2020, SAIF Class 11: The U.S. Treasury Market Jun Pan 21 / 27
Three Rounds of QE, 2008-2014
Total Reserve Bank Credit: $4.45T:Securities Held Outright: $4.22T.
▶ UST: $2.46T.▶ Agency: $39.7B.▶ MBS: $1.72T.
Repo: 0.Loans: $206M.Maiden Lane: $1.7B.Central Bank Swaps: 0.
As of Oct 29, 2014.
Financial Markets, Spring 2020, SAIF Class 11: The U.S. Treasury Market Jun Pan 22 / 27