The U.S. Treasury market is...
Really big...
Roughly $27 trillion in outstanding marketable debt with about $1 trillion trading daily.
The benchmark for investors...
Treasuries are the reference point for pricing risk across all other markets.
The U.S. Government's cost of debt...
The U.S. finances itself through this market. Any sustained disruption directly affects fiscal capacity.
A primary collateral backbone...
Treasuries are the core collateral for repo markets and derivatives, essentially the plumbing of modern finance.
A macro market signal...
Yields reflect expectations for inflation, growth, and monetary policy.
Another unique aspect of U.S. Treasury markets: Safe haven
Investors all over the world buy U.S. Treasuries in times of uncertainty. Historically, when you needed to know you can get your money back, U.S. Treasuries were your safe haven. Why not bet on the U.S. money printing press?
If a tree falls in the woods
Bond yields go down. Bond yields go up.
But if they end where they started, is there damage?
Short answer: yes.
Fixed-income investors want stability (for reasons that will be evident when we get into the weeds below.
Last week was atypically volatile
The 10 Year Treasury yield increased more between Monday and Friday of last week than in 99% of all weeks over the last 50 years.
The $30 trillion question: What’s causing the volatility?
There are two competing explanations. One is about trust. The other is about leverage.
Our goal in outlining these narratives isn't to endorse either. But we outline them below because your view on how and why capital flows will strongly influence your view on investment and career opportunities.
Narrative 1: Eroding confidence in U.S. fiscal discipline
"The times ahead will be radically different than those we experienced in our lifetimes, though similar to many times before." Ray Dalio
Dalio's 500-year study on "changing world orders" suggests the U.S. is following a pattern set by previous superpowers.
The actual path isn't as pretty as the chart above. Lots of volatility around the trend lines, but to Dalio, the long-term trends are clear and repeatable.
Why the pattern?
According to Dalio, leading superpowers benefit from strong currency, so they borrow big until debt service outruns income growth.
These superpowers eventually learn that leverage cuts both ways, but they only (re) learn this lesson when their lenders--the groups financing outsized consumption--begin to look at the megaconsuming countries more skeptically. Similarly, the rest of the world views their currencies (essentially a country's stock price) with similar relative caution.
Notably, President Trump's approach to international trade seems closely related to Dalio's world view. More simplified but definitely parallel: "trade deficits are unsustainable.
Dalio: "Think of this table as a dashboard that paints a rough, current picture of health in order to assess central government and central bank long-term debt risks. In addition to showing risks from existing and projected debt and debt service levels, it includes measures of whether a country is a reserve currency because being a reserve currency country—i.e., having one’s currency widely accepted around the world as both a medium of exchange and a storehold of wealth—is a great risk mitigator, especially if the country is a good place to invest, as is currently the case for the US and its money and debt."
Dalio outlined his views on changing world orders three years ago in this video.
Narrative 2: Unwinding the "basis trade"
We find that the more complicated a subject is, the better it is to track it with ridiculously simple images...
Investors with big portfolios of assets tied to future promises need safety, long-dated maturities, and yield. They often achieve this with a mix of assets that anchors to long-term Treasury exposure.
Hedge funds can provide a solution for those liability-driven investors when market conditions align: small differences between spot prices and futures prices, availability of leverage, and relative rate stability.
Hedge funds can provide the scale desired by those liability-driven investors...
...with a small anticipated profit.
Then they leverage that small profit, turning it into (if conditions remain stable) very significant profit.
Those hedge funds borrow most of the required capital from primary dealers and money market funds through repo agreements. How is so much debt possible? The underlying collateral is the U.S. government and its uniquely valuable printing press.
If rates should rise and bond prices fall during the term of those repo agreements, the dealers and money market funds would simply rebalance with the hedge funds, likely by selling the positions.
But sometimes there are extreme moves, which shake markets. e.g., 9/11, GFC, Covid. ...last week.
Its in those periods when these tactical sellers emerge.
Facing significant pressure from their lenders, the hedge funds need to close their positions.
Treasury futures make up a big market (about $1 trillion), but they only represent about 3% of the total Treasury market.
But a rush to close those $1 trillion of positions pressures a market with about $1 trillion in daily trading activity.
Interestingly, this trade isn't zero sum. Hedge funds don't have to lose in order for the liability driven investors to win, which is why there's such a balance in the market.
Quick review
The U.S. Treasury market is extremely meaningful, in part because it sets the fundamental benchmark for all investors.
Last week was extremely atypical, in the worst 99% of weeks in terms of yield spikes.
And two narratives are emerging to explain what happened: 1) the world is giving up on the U.S. as a reserve currency vs. 2) tactical sellers moved the market temporarily.
No one knows for sure (at least not yet) what happened last week.
But your view of how this fundamental component of the global capital markets is functioning (or not functioning) will undoubtedly influence your view on opportunities and challenges.
Our perspective
We "follow the dollars" like this because headlines often gloss over critical aspects of capital market dynamics.
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