Treasury bill auctions are supposed to be one of the most boring, humdrum happenings in financial markets. They only ever get interesting during moments of financial market stress or panic. And unfortunately, yesterday's got pretty interesting.
"How in the world does a three-month T-bill auction tail 9 basis points?" Andrew Brenner of Natalliance asked rhetorically this morning. "That is the worst since the Lehman situation," although he noted it felt less like a systemic leverage issue than "a replay of the beginning of Covid" when markets seized up.
The "tail" simply means yields had to be much higher than expected in order to place all the Treasuries with bidders yesterday. And it makes sense--who wants to step in front of a steam engine? Yields on three-month bills have shot up from basically zero (0.05%) in January to 1.785% today. They've jumped 15 basis points just since yesterday morning!
It's all because the market has had to rapidly reprice what the Fed is about to do in its two-day meeting that kicks off today and ends at 2 p.m. tomorrow with what is now a widely anticipated to be 75-basis-point rate hike. It was wild watching events play out yesterday afternoon; yields jumping, rumors swirling, stocks selling off, and The Wall Street Journal finally reporting that yes, indeed, the Fed is "considering" that big of a rate hike. That then triggered a raft of firms--J.P. Morgan! Goldman!--to pile on with their calls for a 75-basis-point hike, further forcing it to be priced into markets.
So again, holding even three-month Treasury bills right now is a dicey prospect. And that's how you get a massive auction tail--a "six-sigma event," as one economist put it to me this morning--and growing concerns about rapidly evaporating liquidity in financial markets. Just look at the mortgage market right now, which basically had "zero bids" on Friday, as this same person told me. Spreads have blown out, which is why mortgage rates have spiked nearly half a point (to over 6.1%!) just since the end of last week.
It will be easy to say the Fed shouldn't be tightening so much here and blame them for the market turmoil, but this is not so much them "breaking the glass" just to be safe--they're breaking the glass because the inflationary fire has already broken out, and they didn't quell it earlier on when it might have caused less damage. They have to move quickly--even if it risks a markets "accident"--because the "do nothing" option has now become far riskier in the long run.
And my guess is, the Fed probably feels it has the tools to help short-term market functioning if it has to; it's a playbook it perfected over the past three years, from dealing with the 2019 repo crisis (caused by the original "quantitative tightening"), to keeping markets going during the Covid shutdowns in March and April 2020. They've literally even bought Treasury bills in the past and not counted it as monetary policy, since it was only short-term, not long-term holdings. They're already providing $2 trillion in daily liquidity through their reverse repos.
It would be easy to draw parallels between now and the financial crisis in 2007-08, but frankly it doesn't feel that way to me. Even with oil prices spiking now like they did back then; even with markets acting glitchy; even with the housing market showing signs of turning over. That period felt more like a house of cards that was about to collapse. The housing bubble, remember, had come out of nowhere, and no one could really explain why it was happening. This is not that.
I look around now and I have friends who are still trying to buy houses so they can move their kids out of the city; I see real demand for real assets, in other words. I see shares of big banks already priced for the nadir of the crisis; has anyone seen what's happening with Credit Suisse lately? And I see interest rates swooshing higher, not moving sideways or lower, as they did from mid-2006 onward for the next fifteen years.
So yes, it's getting a little glitchy out there. Liquidity is trying to figure out where it wants to go, and whether it even wants to be there at all. I think some plain talk from the Fed tomorrow would go a long way. Chair Powell--lay it all out. We are raising rates until xyz happens on inflation/breakevens/inflation expectations, whatever it is, spell it out for us. Tell markets. They love a plan. Then they can trade it accordingly. Liquidity can make a comeback.
It still won't be easy. On top of everything our Fed has to deal with, Europe is already risking a rerun of its debt crisis by pulling back on debt purchases of weaker peripheral countries as part of its need to pivot to tightening in order to fight inflation. Italian 10-year bond yields have surged from 0.5% to 4% in less than a year! Japan is meanwhile embroiled in an effort to keep yields and the yen from spiking, which is all resulting in our dollar shooting higher, which is encouraging even more dollar demand globally, since it's been one of the few well-performing assets this year.
Point being, by letting inflation break out to this extent, global policymakers have now boxed themselves in. They can no longer ignore inflationary risks in order to deal with other crises that might require their monetary support. Inflation itself has become the crisis of the first order, to which all other efforts must now be subjugated. That is what's most different this time.
See you at 1 p.m!
Kelly
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