Tuesday, June 5, 2012

Here's One Big Reason That U.S. Treasury Rates Are So Low


Yesterday's FT Alphaville (the blog for the Financial Times) carried an interesting piece on the Treasury holdings of the Federal Reserve.

The piece quoted extensively from a research noted written by Torsten Slok of Deutsche Bank (DB also was the source of the chart shown above).

Here's what Mr. Slok wrote:

In addition, central banks (Fed, ECB, BoE, BoJ) buying government bonds has lowered supply of risk-free bonds real money managers can buy (for example, the Fed currently holds 30% of all 5-10 year U.S. Treasuries outstanding).


Think of that:  nearly a third of all of the Treasury debt trading in the public markets that has maturities in the 5 to 10 year area is being held by our central bank, and not investors.

While there is no doubt that times are uncertain, and the fate of the euro very much in question, but still:

Where would interest rates be if the Fed were not intervening?

I wrote last week that I felt that the Fed should at least consider selling a portion of the $1.6 trillion in Treasury holdings currently on its balance sheet.

Here's an excerpt from what I wrote:

...ever since the first quantitative easing program began, the Fed has been under intense political pressure to demonstrate how it could exit the capital markets without disrupting the economy.

If the Fed sold, say, $100 billion of its position, it would provide a tangible demonstration of just how our central bank could reduce its bond holdings.

...extremely low interest rates are a penalty on savers as well as the nation's financial institutions.  It would seem to me that it is no one's interest to have longer maturity interest rates continue to plunge lower.

..selling some of its bond position would remove the element of the "Bernanke put" that is present in today's market.  Currently most investors and bond traders assume that if the economy showed any signs of plunging lower that the Fed would intervene in the markets again.

Selling bonds today would in essence tell the markets that the Fed's purchase of bonds since the financial crisis of 2008 was only a temporary policy decision, and that it is now looking forward to resuming its role as the Steward of our Banking System.


After looking at the chart shown above, I still believe the Fed should reconsider its current position.