Steve Miran, Trump’s current chair of the CEA, said: “Holding century bonds is less risky for reserve managers if they have access to swap lines granting them substantial short-term dollar liquidity. The desire to maintain access to such swap lines will be a powerful long-term incentive for remaining inside the U.S. security and economic umbrella.”
When you want to derisk, you buy U.S. Treasurys. In times of acute stress, dollars are even more pristine collateral.
Fed independence and the Treasury market: One of the primary reasons that Treasurys are used as reserves is their market depth and liquidity. Trump’s recent promotion of Fed Governor Michelle Bowman to vice chair of supervision highlights that there will be no “shadow chair” and that the Fed will pursue thoughtful deregulation. On several occasions over the past two decades, regulators threatened Treasury-market stability by tightening their grip over the banking system. As the debt stock grows, ensuring that the Treasury market is resilient is even more important.
There is no alternative to the Treasury market at the European Central Bank, given its lack of jointly issued EU debt, and the Fed will remain the global financial system’s fire chief. When you want to derisk, you buy U.S. Treasurys. In times of acute stress, dollars are even more pristine collateral. We’ll likely be talking about threats to the dollar’s status for years to come. But incremental shifts in the balance of global trade and seeking to prevent the debt-to-GDP ratio from spiraling out of control are not going to upset the dollar’s global dominance.
Bessent believes a sovereign wealth fund could be crafted out of the government’s current assets. For instance, the Social Security trust fund (around $2.8 trillion in assets) should be able to invest in equities and other non-Treasury assets to boost returns. The Treasury’s claims on the government sponsored enterprises, i.e. Fannie Mae (FNMA) and Freddie Mac (FMCC), could be shifted to a sovereign wealth fund. Federally owned land could be used as an asset as well. Bessent doesn’t view a revaluation of the government’s gold (GC00) holdings as a credible path to reducing the budget deficit, as some have suggested.
The jury is still out on what a sovereign wealth fund would look like, but if one is set up, it would likely invest in domestic assets and encourage investment. On the margin, the idea can’t hurt.
Is quantitative tightening still on? At its March meeting, the Federal Open Market Committee decided to slow the Fed’s paring of its balance sheet. Previously, the Fed had capped the amount of maturing Treasury securities that could be reinvested at $25 billion. This was lowered to $5 billion, while the $35 billion cap on agency debt and mortgage-backed securities was maintained.
Fed Governor Christoper Waller was the lone dissenter on this action, preferring to maintain the pace of runoff. In a statement, he said that bank reserves remain abundant at more than $3 trillion and funding market conditions remain stable, suggesting no need to tamper with QT. An outside but notable voice, Larry Summers, said that the decision to taper QT was alarming and suggested that the private sector was struggling to absorb the onslaught of debt issuance.
We respectfully disagree with both Waller and Summers. The decision to limit QT was a technical one on the basis of market plumbing and functionality, not one of monetary policy to reflect the real economy. It’s unlikely to have any material impact over the intermediate term, either. Consider the following:
1. Mortgage-backed securities: The Fed would eventually like to hold no mortgage-backed security, just Treasury securities. So there’s currently $2.2 trillion of unwanted debt on its balance sheet. Given that most mortgage holders have much lower rates than prevailing rates today, many having refinanced during the COVID-19 pandemic, there’s little incentive to prepay. That’s lengthened the duration of the Fed’s mortgage-backed-security portfolio and kept the amount of mortgage-backed securities rolling off well below the cap, hence the decision to leave that cap unchanged.
2. Rate pressures: While money-market functioning is in good shape broadly and reserves are quite high, Waller is not necessarily right in saying there are no evident pressures. For instance, the spread between the secured overnight financing rate and the federal-funds rate has been more elevated recently than over the past few years. This suggests financing in repo is getting tougher and tougher on stressful dates, such as quarter-end and year-end.
So while everything is still fine, reserves have still been shrinking relative to GDP and thus their abundancy is diminishing as well. The Fed plans to end QT when reserves are “ample” (which means less than abundant but still much more than needed). The rise in the secured overnight financing rate relative to the federal-funds rate suggests “ample” is approaching.
3. Treasury yields: In theory, QT raises Treasury yields by increasing the supply that the price-sensitive private sector has to hold. It’s the reverse of QE, which involves the price-insensitive Fed bidding up bonds and thereby lowering yields. So we’ve been asked many times what impact tapering QT will have on bond yields. It won’t be nothing but probably will be immaterial.
As the Treasury spends down its Treasury General Account at the Fed to finance the deficit while the debt limit remains unresolved, reserves will get a boost. But eventually, the Treasury will rapidly rebuild the TGA, causing reserves to fall and potentially blowing through the “abundant” level the Fed hopes to eventually reach.
In short, the Fed, mindful of the volatility that could occur, decided to slow its pace of balance-sheet reduction for the time being and thus put less downward pressure on reserve balances. That’s prudent central banking, not a measure to ease monetary policy.
Eric Wallerstein is Yardeni Research’s chief markets strategist. This article is excerpted from Yardeni Research’s “Morning Briefing” for March 25, 2025 – “Meet Scott Bessent.” Individual investors can read Yardeni Research reports here. Follow Yardeni on LinkedIn and his LinkedIn Blog.
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03-25-25 1216ET
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