Updates with post on Fed shorting duration, implications for yields

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GIVEN FED'S UNEXPECTED TWISTS, US 10-YEAR YIELD MAY CONTORT HIGHER

As Big-Tech earnings take center stage, Treasury yields are taking another leg higher.

As Ben Emons, founder of Fed Watch Advisors, sees it, the reason is not just that a December rate cut is now potentially up in the air, given that Powell pushed back against expectations in his press conference on Wednesday, but because of "the two words Powell flubbed: 'shorter duration.'”

"The end of QT, quantitative tightening, should have been, at the margin, bullish for Treasuries," writes Emons in a note.

He adds that the reinvestment flows across the curve, as the Fed steers its portfolio to an average maturity of around 5.9 years, will match the maturity of the outstanding Treasury debt.

According to Emons, it was a surprise that the statement on QT said that maturing MBSs will be reinvested into T-bills.

"Powell said it is to bring the portfolio to 'Treasuries only' (which is well known), but he added that the Fed wants a shorter-duration balance sheet."

Prior to the Financial Crisis, Emons says the average maturity of the balance sheet was less than three years, which was substantially shorter than today. In his view, while Powell said that it will take a long time to reach that point (sub-3-year maturity), "it nonetheless means that resuming reinvestments will not see a 'yield curve control tweak' under Powell."

That potential had excited the Treasury market because it could limit the 10-year US10YT=RR and 30-year US30YT=RR yields from rising well above 5%.

Emons notes that "the unexpected twists" of shorter duration by not deploying MBS runoff into longer-maturity Treasuries come right before the next Treasury refunding details on November 4-5.

"While the rate cut is far from concluded, a 'ways away from neutral' type comment, the balance sheet is on a preset course towards a shorter-maturity profile." At the same time, Emons says the Treasury must fund a $38 trillion debt load with an even bigger wave of T-bills (currently $7 trillion) than previously thought.

Emons' bottom line is that the 10-year yield, which is now around 4.08%, may be poised to break higher as auctions come back into focus as risk events (November 12 is the next 10-year).

(Terence Gabriel)

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