April seventh, twenty twenty-five to April eleventh, twenty twenty-five

I. Foundation 

resistance to change and hence greater dependability for the results shown in the past.

Global Liquidity (One): Interest Rates Are Not the Main Story; Liquidity Is the Key

It’s not about interest rates. It’s about balance sheet...

With the tariffs taking effect, everyone’s attention is turning to the Federal Reserve, The market’s real focus is not a topic like “how many rate cuts,” but whether the entire system’s liquidity and reserve structure remain in an ample regime, and whether it is approaching the edge of a scarce regime.

The Federal Reserve and markets commonly classify liquidity as: ample / abundant / scarce

In fact, since the pandemic, the global liquidity system has been in a highly ample reserve regime over the past few years. Looking further back, our current starting point follows at least a decade of abundant liquidity and a compressed Debt-to-Liquidity ratio. The core reason for this situation is:2008, after the global financial crisis, central banks around the world injected liquidity on a massive scale to stabilize the financial system; during the pandemic, they then implemented further unprecedented liquidity easing.

This round of operations created an extremely accommodative liquidity environment and also lowered the traditional “debt/GDP” ratio. In addition, the prolonged zero-interest-rate environment encouraged many corporations and governments to “extend the maturity” of short-term debt, engaging in what is known as “debt maturity transformation.”

But in the second half of 2024, this model was on the verge of reversing, and systemic reserves were rapidly slipping toward a “scarce regime.”Previously, markets borrowed at extremely low interest rates, pushing out repayment schedules. But these debts with extended maturities are gradually coming due, and the so-called “debt maturity wall” will become a major challenge for capital markets over the next two to three years.

—Large volumes of previously “locked-in” medium- and long-term debt are tending to mature at the same time.

By definition, this reversal in the liquidity-debt relationship is enough to end the current bull market. While it may not yet be enough to directly trigger a systemic bear market, its destructive force can no longer be ignored.

Further reading: Notes250407 Powell and Yellen’s tricks: “Pump and Dump”

If you extrapolate what’s happening at the Fed, the money runs out probably this September. It’s not a question of probability; it’s a question of trajectory.

The essential definition of liquidity can be stated in one sentence: at its core, it is the balance-sheet capacity of the financial system.

This definition is rough and broad, but it is the most basic starting point.

The current system needs more liquidity, and that essentially means expanding balance sheets.

That is why liquidity is so crucial: we live in a “debt-driven” economic system. Debt dominates everything. Every year, enormous amounts of outstanding debt need to be refinanced. Today’s capital markets are no longer centered on “raising funds for new investment projects”; they revolve entirely around “debt rollover.”

Debt rollover requires sufficient balance-sheet capacity within the system. This capacity depends on the extent to which the entire financial system expands. But the expansion of the financial system itself is constrained or guided by the policy boundaries imposed by central banks and regulators.

If the central bank itself is shrinking its balance sheet, it will be difficult for the financial system to expand its balance sheet in tandem. In that situation, the Federal Reserve must intervene again and expand its own balance sheet.

Further reading: Notes250402Locating America (Five), Path Dependence: QE is not called QE, and liquidity injections are not called liquidity injections

Most large transactions in the market are essentially debt rollovers rather than new capital raising. If debt cannot be rolled over smoothly, the market structure will break down. If it cannot be rolled over, this is not a matter of price; it is a matter of survival. So the core issue is not the level of interest rates, but whether there is room on the balance sheet to take on the debt.

If liquidity is insufficient to support the debt structure, systemic risk can be triggered even without rate hikes. The Fed’s continued QT will bring “liquidity compression,” equivalent to stripping the financial system of its refinancing capacity.

Liquidity is currently somewhere between abundant and ample, but “very close to the edge.” If we linearly extrapolate variables such as the current QT pace, RRP depletion, and TGA rebuild, reserves will fall below the system’s critical threshold by 9 at the latest this year, bringing us back into a period of dislocation similar to the repo crisis of 2019 9.

The repo market is already pricing in this situation; spreads in the repo market are steadily widening, which is a very clear trend.This persistent widening of spreads has surely caught the attention of Fed policymakers. They have said they do not want a repeat of the 2019 repo market crisis, but we are now clearly moving step by step toward that brink.

The spread between SOFR and Fed Funds keeps widening; spread widening is the most typical early warning signal, and this trend is almost a shadow of the eve of 2019 9. Uneven reserve distribution in the system, divergent reserve structures at large and regional banks, rapid depletion of RRP balances, and continued QT together form a typical liquidity exhaustion path.

The core of modern liquidity is not a standalone static concept, but a dynamic intersection of liquidity × collateral × balance-sheet capacity.Paying attention to liquidity means paying close attention to collateral, and the repo market is precisely where these two core variables—liquidity and collateral—meet, Repo rates will be a very important indicator this year.

If collateral quality deteriorates and balance-sheet capacity is constrained, the system could suddenly freeze up even if the quantity of reserves has not changed. To understand the current financial system, we cannot look only at interest rates; we must examine the structure of repo collateral, reserve tiers, and balance-sheet availability across the entire system..

Balance-sheet capacity in the banking system is contracting, while regulation is strengthening reserve buffer requirements on banks. This kind of Structural squeeze can only be resolved through active balance-sheet expansion by the Fed or a blowup in shadow credit; there is no neutral option in between.

Further reading: Notes250331Locating America (Three): The Fragile Symbiosis of Private Credit and Pensions

Further reading: Notes250402A non-bailout version of QE: Operation Twist 2.0

We have entered a world driven by debt refinancing, in which the balance sheet itself is the core variable. Today’s markets are no longer those of a world driven by capital expenditure, where interest rates determine investment returns—the defining variable of this era is no longer the level of interest rates, but balance-sheet capacity..

This is a paradigm shift in the macro narrative.

2025.04.07

Powell and Yellen’s tricks: “Pump and Dump”

The essence of “Pump and Dump” is to inject a whole package of hidden stimulus policies into the U.S. economy through a series of rule-bending operations.More specifically, these were a series of operations undertaken by Powell and Yellen during 2024, intended, from one perspective, to boost Biden’s reelection prospects... The result was obviously unsuccessful... However, a package of “hidden stimulus policies” was indeed injected into the U.S. economy.

This hidden stimulus package could be called “QE’s QE”; that is, a series of operations by the Federal Reserve outside its official QT or balance-sheet policy.

“Balance-sheet policy” mainly refers to QT under the current definition of FOMC: allowing U.S. Treasury securities to mature naturally without reinvesting, thereby shrinking the balance sheet. Conversely, if they continue buying Treasury securities, that falls under QE operations.

And this has already diverged from the original conception of QE. If we go back to the Bernanke era, he emphasized that the essence of QE is transmitted through changes in bank reserves (he stated this point very clearly). Now, the Fed’s definitions of QE and QT have increasingly been subject to forced appropriation.

Further reading: Notes250328Four Different Forms of QE: Introducing the Concept of Monetary Financing

Further reading: Notes250328Recalibrating the definitions of QE and QT

“QE that is not QE” refers to Federal Reserve operations outside Treasuries and MBS, including RRP (the reverse repo facility), the reduction in RRP balances, fluctuations in the Treasury General Account (TGA), operating losses on the Fed’s asset holdings, and the now-discontinued BTFP (Bank Term Funding Program), among others—In essence, this is liquidity injected into the system by the Federal Reserve outside its official QT policy. In other words, they are not actually tightening, but are quietly carrying out “hidden QE”; this is where the phrase “not QE’s QE” comes from.

Under Janet Yellen’s leadership, the U.S. Treasury very cleverly chose to finance the government through short-term Treasury securities (bills).Since the end of 2023, more than 60% of U.S. deficit financing has been carried out through Treasury bills, an extraordinarily high share by modern historical standards.

Treasury bills are very short-term government bonds that typically mature within 12 months and pay no interest (that is, they are zero-coupon bonds). These instruments are popular with banks and credit institutions. But When these financial institutions buy large quantities of bills, they are effectively “monetizing the fiscal deficit” directly. If we consider the liquidity generated by the Treasury’s financing-mix adjustments and greater short-term borrowing together with the Fed’s “Not-QE QE” operations, we can see a genuine process of systemic liquidity injection.

At its core, this is a form of “duration management” jointly implemented through fiscal and monetary policy.

This is actually another indirect way of conducting YCC operations.At the beginning of 2024, the total volume of this type of liquidity injection peaked at about 6 trillion dollars, effectively giving the markets and the real economy a shot in the arm. This is very tangible additional liquidity that continues to flow into the system.

Further reading: Notes250402A non-bailout version of QE: Operation Twist 2.0

But over the course of 2024, we can observe that this liquidity stimulus is rapidly winding down, and the remaining stimulus has already fallen below 1 trillion dollars. What really matters is the “second derivative”—that is, the rate of marginal change. Understanding this marginal liquidity contraction is central to judging market and economic direction. Marginal liquidity is highly correlated with the Philadelphia Fed Manufacturing Index for U.S. equities, with a lag of about 9 months.

The global economic slowdown caused by this fading liquidity had already become clearly evident since mid-12 last year. This slowdown began before tariffs became a market focus, indicating that the global economy had already been slowing quietly and was not directly driven by recent trade-friction concerns.

The major factor behind this slowdown is the ebbing of this “hidden stimulus.” That is why we are now seeing evidence of economic deceleration gradually emerge. The rise in tariff uncertainty is only a macroeconomic catalyst that intensifies this trend.

2025.04.07

U.S. Treasuries/Gold: A Geopolitical Relative-Valuation Logic

For sovereign reserve managers, the dollar has no genuine substitute within the existing fiat currency system. Gold may be the only asset without counterparty risk; the problem is that it is difficult to transport and trade, yields no interest, and incurs a holding cost (dollar funding rate + storage cost − convenience yield)Whereas current U.S. Treasuries can provide 4%-5% in interest returns.

Historically, whenever concerns over U.S. fiscal overextension or geopolitical risks intensify, U.S. Treasuries tend to depreciate relative to gold.

The early 2000s are a good example of U.S. Treasuries depreciating relative to gold:

Because the United States had to fight a recession and increase military spending after 9 11. Geopolitical relations were highly tense during the “War on Terror.”

2008-2015, after the global financial crisis, U.S. Treasuries appreciated relative to gold:

The main reasons were 1) the U.S. deficit was not a major issue, because the current account and budget balance did deteriorate sharply, but this was temporary and recovered in 2013; 2) the Fed supported the value of U.S. Treasuries through QE; 3) geopolitical relations were largely stable, and most governments were focused on dealing with the effects of the global financial crisis.

During the pandemic in 2020:

The U.S. twin deficits surged, but U.S. Treasuries remained stable relative to gold because 1) the rest of the world and the United States were “in the same boat,” with a synchronized global recession, while the United States was “the cleanest shirt in the dirty laundry,” relatively speaking the most stable region; 2) governments were busy dealing with domestic problems caused by the pandemic and addressing their own domestic-demand difficulties.

Since 2022:

Since the Russia-Ukraine war and the subsequent financial sanctions took effect, U.S. Treasuries have gradually depreciated relative to gold.

Finally, one of the most important charts for examining the relationship between U.S. Treasuries and gold:

White line = U.S. twin deficits (current account + budget balance, as a percentage of GDP, left axis)

Yellow line = ratio of the total outstanding U.S. Treasury debt to the price of gold

Red shaded area = U.S. recession periods

2025.04.08

Global Liquidity (Two): The Collateral-Driven Liquidity System and Two Control Mechanisms

Activity in the dollar system is shifting from traditional banking to shadow banking, driven by regulatory arbitrage. This structural shift is due in large part to the SLR (Supplementary Leverage Ratio), a regulatory metric that enables shadow banks to bypass capital constraints and expand rapidly.

Regulations have essentially made it extremely difficult, or even unprofitable, for banks to conduct business using their own balance sheets. As a result, a great deal of business has shifted to other nonbank credit providers, or has simply been “moved off balance sheet” and become off-balance-sheet business.

This means that two control mechanisms coexist in the current financial system, which is key to understanding how the entire liquidity system works.

The first is the lender-of-last-resort function—a core responsibility of traditional central banks, which maintain system stability by providing reserves to commercial banks. This function operates through the traditional banking channel, which has traditionally centered on “investment in safe assets” and therefore dampens volatility; in other words, it is countercyclical.

The other control mechanism revolves around the shadow banking system and represents an “emerging function”: the central bank (or the central bank and the Treasury)tries in this mechanism to act as the dealer of last resort, with the core objective of stabilizing or supporting the market value of collateral.

The importance of collateral pricing is self-evident: it directly determines the system’s capacity to generate systemic liquidity.

And This is also where the problem lies with a collateral-driven liquidity system: the further the system shifts toward the shadow side and the more it relies on private debt assets as collateral, the further those assets move beyond the reach of the “official safety net.”—risks become increasingly difficult to control. Ultimately, these mechanisms amplify deviations and reinforce procyclicality (deviation amplifying, pro-cyclical)—and this is the source of a potential crisis: what is the “integrity” of private-sector collateral? These assets are not fully backstopped by central banks or fiscal authorities; that is the greatest systemic vulnerability.What is the “integrity” of private-sector collateral, exactly? It is not fully backstopped by central banks or fiscal authorities, and that is the greatest systemic risk.

Once the macroeconomy begins to slow, this structure can readily trigger a negative feedback loop, potentially leading to a cascade-like breakdown of financial linkages—the kind seen in year 08.

In Series One, we presented a good indicator for monitoring this risk:

SOFR rate (the key rate in the current repo market) and the federal funds target rate.

For further reading: Notes 250407 Global Liquidity (One): Rates Are Not the Main Story; Liquidity Is What Matters

This indicator also has a limitation: it shows where the problem ultimately becomes visible, that is, It is a lagging indicator, not a leading one—it is not forward-looking on its own unless its trend is tracked continuously.

Generally, the earliest signs of reserve stress tend to appear at quarter-end because settlement and regulatory constraints tighten funding flows at quarter-end. The Federal Reserve has indeed intervened several times on this issue, seeking to ease pressure by raising the capacity of the Standing Repo Facility (SRF) and keep funding rates within a reasonable range.But the problem is that, so far, SRF and the discount window have seen very little use—the market has not truly tapped this liquidity lifeline.

Over the past six months, the SOFR rate has remained above the federal funds rate target and has shown frequent fluctuations, indicating that repo-market stress is intensifying.This means the repo market is already experiencing problems. Either there is a shortage of high-quality collateral, or there is a systemic lack of liquidity.In either case, the market’s structure is beginning to break down—and the repo market is the “heartbeat” of the entire financial system, so the current situation is indeed very dangerous.

This is also one reason the Federal Reserve has paused or signaled that it may soon pause QT. Although it has not completely stopped balance-sheet runoff, MBS is still passively shrinking, and Treasury holdings are also falling by about 50 hundred million dollars per month, liquidity pressures have become a policy priority.

The market is now in a phase of “running out of tools.” The various levers the Federal Reserve has frequently pulled over the past four years—such as RRP—are now nearly exhausted, with balances close to zero. Only temporary quarter-end funding activity remains, and TGA cannot take over sustainably, In other words, nearly all the major liquidity levers have now been pulled to their limits—a very clear outcome is emerging: this system now needs new intervention tools.

2025.04.09

II. Insights 

Our Viewpoints and ideas on market.

If Recession Returns: A Simple Framework for Analyzing Gold and U.S. Treasuries

If the next U.S. recession arrives—whenever that may be—the twin deficits will probably surge again. The central question is: will U.S. Treasuries depreciate against gold then?

A simple core framework for judgment based on multiple factors, To reiterate, we are discussing a relative trade here, not absolute performance：

For further reading: Notes 250408 U.S. Treasuries/Gold: A Geopolitical Relative-Value Rationale

1. A U.S.-only recession?

If the next possible recession affects the United States more than other countries, the market may devalue U.S. Treasuries relative to gold amid concerns about fiscal overextension. If the global economies are “in the same boat,” then UST may retain its value against gold, as it did after the global financial crisis and Covid.

However, China’s current position in the economic and market cycle differs significantly from that of the United States so a future U.S. recession may not affect China as significantly as it has in the past.

The likelihood of being “in the same boat” is declining sharply; from this perspective, U.S. Treasuries will depreciate relative to gold.

2. Is the geopolitical situation stable or volatile?

If the ongoing conflicts in the Middle East, the Russia-Ukraine war, and geopolitical problems elsewhere continue to escalate, or if U.S.-China relations deteriorate (which may first show up in tariff disputes), other central banks may continue diversifying, shifting from UST into gold, althou although diversification itself is the major trend, geopolitics mainly affects its pace and creates short- to medium-term trading shocks (7-14 weeks).

3. Who will buy large amounts of UST in the next recession and absorb the next wave of Treasury issuance?

As foreign holders reduce their holdings, U.S. domestic entities (the Federal Reserve, banks, mutual funds, banks, pension funds, and households) have been increasing their share of UST ownership, For more on this shift of holders toward domestic investors, read the piece on the Mar-a-Lago Accord alongside this one.

For further reading: Notes 250325 The Stillborn Mar-a-Lago Accord

4. Is the petrodollar system stable? This is the question about the Petrodollar.

The widespread use of the dollar in global oil and gas trade sustains natural demand for U.S. Treasuries. Major Middle Eastern oil producers indirectly turn oil revenues into additional demand for Treasuries through exchange-rate regimes pegged to the dollar. If the “petrodollar” system is disrupted, demand for Treasuries may be affected again.

The dollar’s overwhelming use in global oil and commodity trade increases demand for UST.Major Middle Eastern oil producers maintain currencies pegged to the dollar. Through these exchange-rate regimes, they indirectly turn oil revenues into additional demand for U.S. Treasuries, so oil-revenue surpluses indirectly support demand for UST.If the “petrodollar” system is disrupted, demand for U.S. Treasuries may be affected again.

A good thing to watch here is the alignment between oil-producing countries’ policy moves and those of the U.S. ruling party. Producers often make statements or suddenly raise or cut output at certain key moments.

2025.04.08

Basis fluctuations are more a symptom than a root cause (Understanding basis trades)

Recent discussion in the market about the bond basis has stirred considerable controversy and confusion, In fact, since the basis reversal event in 20, 3, it has often been blamed for causing market volatility.Although basis trades are extremely large in scale, for now, exiting by delivering positions into futures contracts can still effectively limit risk.

One. The starting point of the basis problem

Money managers (what Wall Street calls “Real Money”) would rather put cash into corporate bonds and structured products for higher returns than buy off-the-run U.S. Treasuries.Therefore, They buy basis products and fill the gaps in their Treasury risk portfolios by buying futures.

These real-money purchases push futures prices higher and so Hedge funds (HFs) take the opposite side of the trade: they sell futures and buy off-the-run U.S. Treasuries (financing them through the repo market).

So, at the end of the day, this is essentially an arbitrage pair trade between LOs and HFs.

A pure basis trade means that hedge funds buy the cheapest-to-deliver security (Cheapest-To-Deliver, CTD) to deliver into the futures contract. In practice, however, many hedge funds also choose relative-value trades, buying Treasuries that are slightly cheaper rather than CTD.

Two. So how do hedge funds exit these positions?

Real-money longs in futures roll their positions into the new front-month contract at the end of each quarter. Hedge funds typically take the opposite position at the same time and roll into deferred contracts.

However, Hedge funds short futures can also choose to deliver CTD to futures longs on the delivery date.The delivery option means shorts know they can always exit the position at delivery at a basis of 0—hedge funds’The risk in basis trades mainly comes down to whether they can hold the position until the delivery date(or, in other words, whether anything prevents them from holding the position until delivery)..

Three. What happened in 20, 3?

At the time, the futures contract rolled into the new front-month contract at the end of 2, and the delivery cycle was relatively late (when the coupon on CTD is higher than the repo rate, the short should deliver at the end of the delivery month; if the coupon is below the repo rate, delivery should take place on the first day of the delivery month).

Simply put, when the coupon on the cheapest-to-deliver security (CTD) is higher than the repo rate, the short (seller) will choose to deliver at the end of the delivery month. This is because the cost of holding CTD is lower, making delivery more profitable. If the coupon is below the repo rate, the short will choose to deliver on the first day of the delivery month because that reduces carrying costs.

When the pandemic led to a global economic lockdown, there were still 3 and a half months until delivery. Many traders shifted to working from home, and market participation and liquidity both fell sharply. The original delivery horizon (delivery 3 and a half months later) then seemed very long, especially amid a sudden global crisis, when investors could not accurately predict market direction and risks.

In this situation, investors’ demand for safe havens caused U.S. Treasury futures (long-term debt) to outperform off-the-run U.S. Treasuries, changing the profit and loss of basis trades.

The basic logic of a basis trade is the price gap between the futures market and the cash market and when the market became turbulent, some hedge funds (HFs) concluded that basis trades were no longer profitable and had to close out their positions, while These position liquidations caused further market volatility and put pressure on other hedge funds.

These liquidations caused sharp market-price swings, pushing basis-trade pricing to historical extremes. During this process, institutions able to step in promptly and take the other side successfully earned 1/3 to 1/2 basis points by holding the futures position through delivery.That was because they knew that as long as they could hold on until delivery, prices would return to a reasonable level. Once the Federal Reserve began buying Treasuries, these investors exited the market more quickly and locked in profits.

Four. Is there a risk of this happening again today?

Although crowded leveraged positions may increase the risk of a disorderly market reversal, the fundamental risk of basis trades remains relatively small compared with other crowded positions, because the delivery mechanism provides a backstop (at worst, the position can be held to maturity).

Additionally, for most futures contracts, delivery takes place on the first day of 6. This means that those currently holding these positions know they need to hold for only another 7 and a half weeks before exiting at delivery at a basis of 0.

Even with poor liquidity and reduced risk appetite, if heavy position liquidations occur, someone will probably step in quickly to take over the trade, based on the current outlook. Therefore, The time remaining until delivery is a key factor in basis risk.

This also means that trying to blame this week’s volatility on the bond basis is a fallacy.This week’s turmoil is actually a problem of intermediation capacity...

These intermediaries (mainly some dealers) did not have enough balance-sheet capacity to absorb the demand for Treasury sales from U.S. equity-market investors forced to sell after the S&P 500 index fell 6% on Friday. That is, Many institutions holding U.S. equities sold Treasuries to meet margin requirements, creating selling pressure in the Treasury market. Dealers lacked the liquidity to absorb these sales, which amplified market volatility.

Basis fluctuations are more a symptom than a root cause. Ultimately, the problem lies with balance sheets and liquidity. We will explore this further in the liquidity series. After reading this piece, you will see why it is important not to lose sight of the fundamentals and to focus on what matters.

2025.04.10

Global Liquidity (Three): Liquidity Re-injection and Bessent’s Dilemma

With all known levers exhausted, the next step must be a new round of liquidity re-injection. What we really need to face now is this:The Federal Reserve’s balance sheet must expand continuously. According to Michael Howell’s estimate, annual growth of 8% over the medium term is a fairly reasonable steady-state path.

In a debt-driven economic system like this, continued debt growth is an irreversible fundamental reality. To keep the system running, balance-sheet capacity must expand in tandem; otherwise, debt cannot be refinanced = financial crisis.

Every financial crisis over the past three or four decades has, at its core, been a crisis of “failed debt refinancing.”And after every crisis erupts, central banks have no choice but to return to the market and conduct a systemic bailout.

If the Federal Reserve does not step in proactively during the rest of this year, it will likely have to return to the market “passively” and on a large scale after a more serious systemic failure, The Federal Reserve will probably restart some form of QE as soon as possible (they will not call it QE, but will package it under a new name and disguise it as something else), and this outcome will probably occur sometime this year.

The current Federal Reserve actually has two goals: first, to “normalize” its balance sheet; second, to shorten the duration of its assets, holding only short-term Treasury bills as it did 2008 years ago rather than large amounts of long-term assets. In reality, these two goals cannot be achieved...Offloading a large amount of duration risk onto the private sector is actually disastrous for the private sector itself, because in essence it actively drains liquidity from the system.

The “debt refinancing wave” is the underlying force driving the system today.

From Bessent’s perspective, what he wants to do is lower long-term Treasury yields and try to redirect the center of economic activity back toward the private sector. The core goal is to bring down long-term borrowing rates.Given the current structure of U.S. fiscal debt, the situation is extremely difficult. The hand he inherited from Yellen is far from easy—she issued Treasury bills on a large scale during her tenure.

The bond market is entering a more complex phase of structural pricing: duration asymmetry + a more concentrated buyer base + a globally synchronized rise in the term premium.

For further reading: Notes 250407 Powell and Yellen’s Tricks: “Pump and Dump”

This is the Treasury Department’s predicament now. Yellen’s “legacy” has made the situation exceptionally difficult for her successor, who faces a set of extremely challenging structural constraints. Beyond that, The bigger problem is that, from an international perspective, the United States is in a more difficult position than it was a decade ago. There are far fewer “international buyers” willing to buy U.S. Treasuries now than there were ten years ago.

For further reading: Notes 250116 The U.S. Treasury’s Intrigue: Neither Inflation nor Debt

China has clearly reduced its holdings, and demand from Japan is no longer what it once was, U.S. fiscal financing now relies increasingly on offshore hedge funds to take down these bonds, a phenomenon most directly reflected in Treasury basis trades.

For further reading: Notes 250410 Basis Fluctuations Are More a Symptom Than a Root Cause (Understanding Basis Trades)

The question now is where the United States can find overseas buyers and more troubling, the “term premium” is rising broadly across global markets—one of the core components of bond-market pricing, which directly pushes up long-term yields.

For further reading: Notes 250325 The Stillborn Mar-a-Lago Accord

The term premium is rising because fiscal deficits are also surging in other countries around the world. China has said it will increase Treasury issuance, and Germany has already begun expanding its balance sheet. Against the backdrop of the tariff war, This fiscal-led stimulus system will become the central narrative and will only intensify.

If the economy slows and the Federal Reserve is forced to cut rates, the yield curve will continue to steepen significantly—and this is already happening quietly.

2025.04.11

Global Liquidity (Four): The Anchor for Treasury Yields and the Misalignment in the Pricing System

Money-market liquidity and the operation of interest-rate mechanisms have a significant effect on the pricing of other asset classes.In fact, if the term structure is calculated using MBS rather than conventional U.S. Treasuries as the benchmark (for example, the PAR curve), the current interest-rate curve is systematically understated. More importantly, This undervaluation creates second-order effects in the market, particularly in the calculation of breakeven inflation, where it directly leads to systematic underreporting.

MBS is essentially backed by the government; the Federal Reserve itself holds a large amount of MBS and treats it as a risk-free asset. But compared with Treasuries, MBS usually has longer duration and higher convexity—meaning its yield is more sensitive to changes in interest rates.

If the yield on MBS is adjusted to match the duration and convexity of conventional Treasuries, producing an equivalent 10-year Treasury yield, and then compared with the actual 10-year Treasury, the difference is exactly 100 basis points.In other words, the actual Treasury yield is a full 100bps below the appropriate “MBS-equivalent yield”; it is being systematically suppressed, and this divergence is closely linked to the large-scale issuance of Treasury bills.

When Yellen favors financing through short-dated T-bills, a structural “coupon scarcity” problem emerges in the system: a shortage of long-term coupon-bearing bonds. This directly causes actual Treasury yields to diverge substantially from their theoretical values.

The first direct consequence is this: if the suppressed 100 basis points are added back to the 10-year Treasury yield, then The Treasury yield curve was not inverted at all over the past two years In other words, The so-called “inversion = recession signal” is fundamentally a false signal.

Second, if breakeven inflation (BEI) is calculated using rates adjusted for actual duration, then Current market inflation expectations are actually being underestimated by about 100 basis points.Moreover, compared with the official BEI data, the adjusted figure is also more highly correlated with the University of Michigan’s consumer expectations survey.

This means: 1) underlying inflation in the system is actually much higher than the market expects; 2) the predictions made by many people over the past two or three years that “the United States would fall into recession,” based on the inversion, never actually came to pass.

This is a very important concept, because the market’s entire discount-rate system is anchored almost entirely to the 10-year Treasury yield. If that anchor is wrong, the entire valuation framework will be misaligned.

To reiterate, The main cause this time ultimately comes down to Yellen’s active fiscal issuance policy, focused on short-duration debt, the previous administration really left a major landmine for the Trump administration; never in the many historical rounds of QE has this kind of structural deviation in yields appeared.

How does it self-correct?

The answer is simple: repricing the term premium will ultimately bring about a recovery.

2025.04.11

III. Market Pulse 

Our latest Comments on the economic and market environment

The CNY depreciation this round + why to keep holding the two trades mentioned earlier

USD/CNY broke through the 7.3 threshold, signaling further room for renminbi depreciation. Strategically, we continue to short high-beta currencies and go long the Swiss franc and yen. There has been extensive discussion of this in the group, so I will not list it all here;We explained the rationale for these two trades to everyone 1-2 months ago. They have now entered profitable territory, so there is no rush to close them.

It is worth noting that The depreciation of CNY against USD in this round differs from the situation during the 2018 trade-war period:

Although the dollar has continued to weaken against most major currencies and gold since 2025, the renminbi has continued to depreciate. 7.3, a key resistance level that had acted as support several times over the past few years, has now been broken, making this a highly significant move.

In 18, the renminbi weakened at the same time as the dollar strengthened broadly. This time, however, the move is not driven by a stronger dollar or a widening U.S.–China interest-rate differential; it is more structural in nature reflecting deeper economic vulnerability and a renewed escalation in external trade pressures. After China retaliated against the “Liberation Day tariffs,” the U.S. government announced additional tariffs of 50% on imports from China, reigniting trade tensions.

Domestically, the current situation is caught in deflationary pressure, It is inevitable that policymakers will step up stimulus Although the authorities continue to stress the importance of exchange-rate stability, at present it does appear that There is a high probability that they will continue to tolerate further depreciation of CNY to 7%, down to 5%, to partially offset the impact on exports to the United States.

If things continue to unfold as we expect, weakness in CNY will keep weighing on high-beta developed- and emerging-market currencies, while further boosting the performance of safe-haven currencies such as the Swiss franc and yen, That is why, as mentioned at the beginning, there is no rush to close these profitable trades，In the first round, these trades were based on U.S. fundamentals. Now we are in the second trading cycle, focused on our own side’s policies. When the policy measures have run their course, it will be time to close the positions for a profit.

2025.04.09

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