Here at HR, we like to present both sides of the argument when it comes to markets.
When it comes to politics, we like to present both sides of the story (hey look, it’s not our fault that the political story is one-sided right now – after all, we didn’t write it).
Unfortunately, we can’t say the same for some other popular commentators. True, everyone is biased (we certainly are) and everyone has an agenda (we certainly do), but despite what some readers say, we don’t push our biases nearly as hard as most other outlets that do what we do. Just today for instance, we published a great guest post on why European stocks could be set for an epic melt up (i.e. a bullish post).
Well, in the true spirit of keeping coverage balanced, we thought it would be a good idea to highlight the latest from Bloomberg’s Cameron Crise, who notes that contrary to popular belief, central bank liquidity from the ECB and the BoJ may not have that much of an effect on US yields after all.
Now needless to say, we’re skeptical and by “skeptical” we mean “on the verge of calling bullshit,” (what happens when you account for GCC and EM FX reserve accumulation?), but as Crise notes, “it’s always a good idea to challenge preconceived notions by delving into the data [and while] we sometimes find our convictions are strengthened, [other times] we find an answer other than the one we’re looking for.”
While the Fed moves slowly toward shrinking its balance sheet, neither the ECB nor BOJ seem interested at the moment in slowing the expansion of theirs. What does the ongoing expansion of global liquidity mean for Treasury investors? It turns out the answer may be “not much.”
- In performing financial market research, sometimes your investigations take you in the opposite direction from the one you intend. In setting out to demonstrate that ongoing QE in Europe and Japan would keep a lid on Treasury yields, I found that they don’t matter that much one way or another.
- I regressed the US 10-year yield against a range of variables: core PCE inflation, the unemployment rate, the Fed funds rate, and Fed expectations proxied by the slope of the 2nd vs 6th eurodollar contracts. I ran three separate studies: one with just these variables, one with the size of the Fed balance sheet, and one with the combined size of the G3 central-bank balance sheets.
- I expected to find a lower model projection using the balance sheet input. In fact, there was virtually no difference between the model outputs, with stable coefficients across the other variables. Currently the gap between the model with the G3 balance sheets and that with none is about 20 bps.
- OK, perhaps the output is distorted when looking at levels. What happens if we model changes in the 10 year yield? It turns out that the answer is the same: virtually no change between models with and without balance sheet data.
- One possible criticism of this approach is that the eurodollar variable is essentially measuring the same thing as the 10-year yield. While it is true that the two variables are highly correlated at the moment, that has always not been the case for much of the last 20 years. It is safe to say, however, that central bank balance-sheet activity has influenced the pricing of the eurodollar curve.
- It’s always a good idea to challenge preconceived notions by delving into the data. Sometimes we find our convictions are strengthened, which gives us the confidence to look through market noise. Occasionally, however, we find an answer other than the one we’re looking for.
- The important thing is to ask the questions, and in this case, don’t believe the hype surrounding central bank balance sheets and Treasury yields.