Treasury and the Fed May Be Recreating the Yellen Liquidity Regime

This intervention was never large enough to reverse the rise in long-term yields and I am now leaning towards the thesis that Treasury and the Fed are setting the stage for a regime similar to the one we saw under Yellen after listening to Bessent's interview last week. A refresher on Yellen’s regime -  2023, Yellen slowed the increase in longer dated issuance and financed more of Treasury’s borrowing through short term bills (sound familiar?). She then launched the buyback programme at $2bn per operation which Bessent increased to $4b The policy helped suppress the term premium, while the large reverse-repo balance allowed money-market funds to absorb the additional bills without draining bank reserves. Once the Fed also came out more dovish, both parts of the yield equation moved lower together and the expected path of policy rates fell while Treasury’s issuance strategy limited the term premium. That supported bonds, equities and liquidity If you are not familiar with the yield equation:  Long-term yield = expected path of Fed rates + term premium The Fed mainly controls the first part and reasury can influence the second   I still think the market has become too hawkish on the Fed and If they simply come out more dovish than currently priced we’re going to see both parts of the yield equation move together - lower expectations for future policy rates and a lower term premium from reduced duration supply. Basically,Treasury and the Fed are recreating the Yellen regime. That combination is supportive for bonds, equities and broader liquidity, much like the regime that was designed under Yellen. Now, the main thing is that the buffer that Yellen had to absorb bill issuance without draining bank reserves (RRP) is not there anymore. However, this could give the Fed an excuse to start reserve management purchases and the combination is very similar to QE. Even if we get a more hawkish Fed and Waller does not play ball, increasing long term yields,Bessent said that he is ready to increase the operations even more thus pulling more liquidity from bank reserves and again forcing the Fed to buy bills or repo. Now, to tie things up, leveraged funds have been building shorts on the Ultra Bond Futures for the past year (CFTC data, 37th percentile short), and while this is a part of the so called basis trade (long cash treasury + short treasury futures + repo financing ), they can still get squeezed if we get a more dovish Fed or weaker macro despite the trade being hedged. Futures can rally faster as this is the fastest and most liquid way to add duration after a dovish surprise and the fund then loses more on its leveraged futures short than it earns on its cash bond and gets margin called thus having to unwind. Not Financial Advice, always do your own research