From Bridgewater Associates, August 4:
Transcript: What Ever Happened to the Liquidity Hole?
Co-CIO Greg Jensen explains how changes to the composition of US debt issuance has temporarily averted some of the most important consequences of the tightening, and why this support to assets is likely to turn into a drag.
The “liquidity hole” is a term we’ve used in the past to describe the bearish pressure on bond yields due to the confluence of a number of important forces, including the Fed’s quantitative tightening and very large US government budget deficits. We expected the combination of these forces—particularly the Fed selling bonds and the Treasury needing to issue more debt—would add a significant amount of duration to the market and that this would suck money out of cash and assets, resulting in higher interest rates and lower asset prices.
What transpired was different, and, we believe, important for investors to understand despite its technical nature. In short, the Treasury has actually reduced net bond issuance and increasingly filled the funding gap created by deficits and QT with T-bills and spending cash on hand instead of issuing bonds. This has counteracted the impact of the liquidity hole and supported asset prices.
However, when we look at the Treasury’s goals and stated intentions, we think the liquidity hole we expected has been delayed but not eliminated. As the Treasury, advised by the Treasury Borrowing Advisory Committee (TBAC), stated in its quarterly refunding announcement earlier this week, bond issuance is now set to increase and will quickly approach a level more consistent with the large federal budget deficit.
We’re sharing a recent conversation between Daily Observations editor Jim Haskel and co-CIO Greg Jensen, in which they discuss these dynamics in more detail. You’ll hear Greg describe the mechanics of how the US Treasury changed its issuance patterns in a unique way, why this is likely not sustainable, how he’s assessing the impact of the liquidity hole going forward, and what all of this means for investors.
Below, we’ve also included a few visuals that help illustrate some of the key points from the discussion.
TRANSCRIPT
What Ever Happened to the Liquidity Hole?
Note: This transcript has been edited for readability.
“You’re still for an extended period of time going to have a budget deficit much bigger than the bond issuance absorbing that liquidity. That creates a level of money to slosh around in the real economy. I think that’s part of why the real economy has been as strong as it has been, is the budget deficit has had a larger multiplier effect because less of it’s being pulled out by duration and issuance. And that will continue. So that’s a positive dynamic. But on a change basis, bond issuance is rising at one of the fastest rates that it’s ever risen. This is a massive—a big change by Treasury standards into that world that we were talking about before. The Fed won’t be buying them. Banks are still unlikely to be buying them. So you’re starting to get what has been contained out there.”—Co-CIO Greg Jensen
Jim Haskel
I’m Jim Haskel, editor of the Bridgewater Daily Observations. The liquidity hole is a term that we’ve used to describe the bearish pressure on bond yields due to the confluence of a number of important forces, including the Fed’s quantitative tightening and very large US government budget deficits. We expected the combination of these forces, particularly the Fed selling bonds and the Treasury needing to issue more debt, would add a significant amount of duration to the market, and that this would suck money out of cash and assets and result in higher interest rates and therefore lower asset prices.What actually transpired was a bit different, and we believe important for investors to understand, despite its technical nature. In short, the Treasury has actually reduced net bond issuance and increasingly filled the funding gap created by deficits and QT through the issuance of T-bills and spending cash on hand instead of issuing bonds. This has counteracted the impact of a liquidity hole and actually supported asset prices.
However, when we look at the Treasury’s goals and stated intentions, we think the liquidity hole we expected has been delayed, but importantly, not eliminated. As the Treasury, advised by the Treasury Borrowing Advisory Committee, or TBAC for short, announced in its quarterly refunding announcement earlier this week, bond issuance is now set to increase and will quickly approach a level more consistent with the large federal budget deficit.
So in today’s podcast, we’re sharing a conversation I had on Wednesday with co-CIO Greg Jensen to discuss these dynamics in more detail. And you’ll hear Greg describe the mechanics of how the US Treasury changes issuance patterns in a very unique way, and why this is likely not sustainable. You’ll also hear how he’s assessing the impact of the liquidity hole going forward and what all of this means for investors. And then we’ve also included a series of charts in the text of this Bridgewater Daily Observations that helps illustrate some of the key points from the discussion. So with that, let’s get right into the first question for Greg.
So, Greg, thanks so much for joining me. One of the big dynamics we’ve been tracking for a while now is the liquidity hole—basically the Fed rolling off its balance sheet and growing deficits and how these upward pressures on duration supply would enhance the tightening and be a big pressure on assets, especially with banks and the Fed, two of the biggest bond buyers, now largely out of the market. Yet we really haven’t seen that happen....
....MUCH MORE, including charts.
