US Treasury Becomes Activist Debt Issuer to Juice the Economy

The US Treasury’s focus on issuing short-term bills to limit price discovery at the back end of the yield curve is keeping interest rates down on longer maturity instruments. This practice is supporting risk assets and stimulating the economy, but it’s also costly with short duration securities currently having higher financing costs then longer duration bonds. In this podcast, IBKR Senior Economist Jose Torres and IBKR Chief Market Strategist Steve Sosnick interview Nouriel Roubini and Stephen Miran to explore the downside of the Treasury as an activist issuer.

Summary – IBKR Podcasts Ep. 186

The following is a summary of a live audio recording and may contain errors in spelling or grammar. Although IBKR has edited for clarity no material changes have been made.

Jose Torres 

Hello everyone, and welcome to Interactive Brokers, IBKR podcast. I’m joined today with my co-host, Chief Strategist, Steve Sosnick.  

Steve Sosnick 

Pleasure to join you, Jose. Great to see you.  

Jose Torres 

Terrific. Nouriel Roubini.  

Nouriel Roubini 

Hi everyone, great pleasure being on this podcast. 

Jose Torres 

And Stephen Miran.  

Stephen Miran 

Hey, Jose. Great to see you. Thanks for having us. 

Jose Torres 

Terrific. Quick bios. Nouriel Roubini is a Senior Economic Advisor to Hudson Bay Capital. Dr. Roubini is also Professor Emeritus, Stern School of Business, New York University, and CEO of Roubini Macro Associates, LLC. From 1998 to 2000, he served as Senior Economist at the White House Council of Economic Advisors and the Senior Advisor for International Affairs at the U.S. Treasury. He is the author of numerous economics articles and four books. Dr. Rubini received an undergraduate degree at Bocconi University in Milan, Italy, and a Ph.D. in economics at Harvard University. Stephen Miran is Senior Strategist at Hudson Bay Capital. Previously, Dr. Miran served as Senior Advisor for Economic Policy at the U.S. Department of the Treasury, where he assisted with fiscal policy during the pandemic recession. Prior to Treasury, Dr. Miran worked for a decade as an investment professional. Dr. Miran is also an Economics Fellow at the Manhattan Institute for Policy Research. He received a Ph.D. in Economics from Harvard University and a B.A. from Boston University. Welcome, gentlemen.  

Stephen Miran 

Thank you.  

Jose Torres 

So, Nouriel, if I can go to you first. So activist treasury issuance his research is very popular amongst the street. Myself and Steve Sosnick, we spoke about it as soon as you guys released it. Miran and myself, we’re good friends too. A lot of issuances are going on at the front end of the curve, lacking price discovery on the longer end, suppressing those yields and letting risk assets go higher. 

Can you expand on that, Nouriel?  

Nouriel Roubini 

Yes. In this paper that I wrote together with Steve, we showed that for the last few quarters, the U.S. Treasury has radically changed its debt management by issuing a much larger fraction of its debt as short-term bills and issuing less of the longer-term debt. It’s called coupons. 

That is implied that the factor is a form of backdoor quantitative easing. When the Fed does quantitative easing, they buy long term bonds. The price goes up, the yield falls. That’s an easing of financial condition that boosts not only asset prices, but also the real economy. Instead, in this case, what the Treasury is doing instead of affecting the demand for Treasuries is affecting the supply. 

And for any given demand, if you supply less, again, the price goes higher, the yield falls, and that eases financial condition. Now, it’s problematic because the Fed has been trying to cool down the economy. Growth was above potential, inflation above target, and it pushed the Fed funds rate to the current level of 5.5. But until recently, the economy has been growing faster than potential in spite of the Fed tightening, and inflation has fallen, but more slowly than the Fed was expecting, and it’s still by some measure well above the 2 % target. Our interpretation is that What the treasurer has done is equivalent in terms of the amount of less issuance of long-term treasury to a trillion-dollar equivalent less of issuance of treasury. 

If you look at the literature on quantitative easing, when you do that, it’s as if the Fed had cut The Fed funds rate, the policy rate, by 100 basis points, or equivalently, that the 10 year treasury yield is lower by 25 basis points, compared to what it would have been without this ATI. So, the way we think of what’s happened in the economy is the Fed was trying to cool down the economy. 

The Treasury was worried about maybe a hard landing or something like that. And it’s undone in partly what the Fed has done through this ATI policy, keeping yields lower, effectively the Fed funds rate lower than what the Fed wants. And that explains why growth has been strong and inflation has remained well above the target of the Fed. 

Steve Sosnick 

So, the implication then would be that we would be looking at a yield curve that is no longer inverted. Do you feel that’s muddied the signals in such a way that it’s the usual recession signal that’s given by an inverted yield curve has been neutered by this activity?  

Stephen Miran 

Sure. We estimate that the effects would be about 50 basis points of higher yield on the 10-year note if the Treasury reversed its unconventional issuance policies. 

A 50-basis point increase would make up about half the distance to un-inverting the yield curve, but it wouldn’t totally un-invert the yield curve. So, you’re talking about 50 basis points in the 10-year yield, that’s material. Risk assets will notice, markets will notice, yields will notice, the economy will notice. 

But you’re not talking about the type of move that’s going to sort of single handedly create giant economic shockwaves.  

Jose Torres 

So, what do you think are the medium to long term costs going on this kind of policy? I mean, I know in your paper you write about this is sort of the politicization of business cycles. Do you want to expand on that?  

Stephen Miran 

There’s a couple of costs, right? One is that we’ve been issuing at the most expensive part of the yield curve. By issuing a lot of short-term overnight debt in, as, Sosnick said a moment ago, in, in an, in a heavily inverted yield curve, we’ve been issuing at the most expensive place to fund ourselves. 

So interest costs have been higher. than if we had issued further at the yield curve. Another cost of doing it is by increasing our exposure to rollover risk. And say there’s some geopolitical event, oil prices go up by 30 a barrel and interest rates go higher when the Fed hikes again. 

We now have to, we fund ourselves, roll over the short-term debt that we’ve rolled over at higher rates. And then there’s the political consequences of potentially sort of giving a tool to manage the interest rate cycle, manage the business cycle, away from what is theoretically an independent central bank, and giving them more towards politically appointed, Officials of the Treasury Department. That falls square into an area called Political Business Cycles that Nouriel’s written extensively on, and really sort of created an entire academic literature on, so I’ll let him handle that. 

Steve Sosnick 

I guess going forward then, see here’s the question that I have though. Let’s take politics out of it. Let’s say I’m managing a corporation here. I might be tempted to borrow money short term rather than locking in long term rates, even though it would appear advantageous to do so if I think the Fed is going to aggressively cut rates. How much of this do you think is political? How much of it is just, do you think that the Treasury is banking on the Fed hoping that independence stays put?  

Stephen Miran 

Yeah, so first of all, Treasury does not do that. It is official Treasury policy not to try to time the interest rate cycle. It’s officially in the policy frameworks, Secretary Yellen has reaffirmed this recently in sworn testimony to Congress. So, claims that treasury is doing it to try to, to time the interest rate cycle, because they expect that cuts are sort of implicitly suggesting that she perjured herself. 

Treasury says this is not happening. We don’t think this is happening either. Principally because you have to get. It turns you into someone who’s betting against the market. So remember the way that fixed income works is that the 10-year yield. Reflects the average expected overnight rate over the course of 10 years. 

Another way of saying that is that you have to beat the forwards in order to make money in fixrisked income. You have to beat what’s priced into the yield curve already. And if the forwards come true, if the yield curve as it is now realized, you will not make or lose any money doing 10 years now or just continually rolling overnight. 

If the forwards are realized, you will not make or lose any money. You have to beat the forwards. So, you are implicitly making a bet that the market is wrong. That you were right, that you know better than the market. And Treasury is humble enough to know that’s not always a winning strategy and that they can get it wrong. And that getting it wrong could be enormously costly, not only to the taxpayer, but to the financial system as well, because of unnecessary volatility in the system. Now, in a market which is already pricing 200 basis points of cuts from the Fed in a 9 – 12-month period, you have to get more than that 200 basis points of cuts in order to make money on this, on the strategy you just described. 

So the Fed has to cut by, let’s say, 250 or 300 basis points a year. in the next nine months, not just 200. That’s quite a tall order and is suggestive. And if Treasury were following the strategy, which they say that they’re not, and we believe that they’re not, they’d have to, they’d have to really be expecting a recession around the corner, in which case there’s a whole other set of policies they should be doing that extend far beyond the issuance strategy. 

Steve Sosnick 

Why do it? Then why are they doing this?  

Nouriel Roubini 

Well, usually the issuance of shorter-term bills is large. When there is either a recession or there is a liquidity crisis or there is a financial crisis or like in COVID, when we had a shock to the markets, and you had to issue a lot of debt to finance a temporary, very large budget deficit. 

So that will be justified. But if you look at the last year or so, the economy is growing above potential. There is no financial crisis. There were some ripple effects coming from Silicon Valley Bank, but then they disappeared, growth is strong, inflation is still above the target, and there is no other explanation of why they are doing this thing. 

The claim is not driven by politics, but the reality is there is no other clear explanation. And I think what happened was that last summer, suddenly the bond vigilantes woke up, even for the United States, first time in a long time, when they realized the deficits were huge in the U.S., Europe, and advanced economies. 

And suddenly, bond yields went much higher. The 10-year Treasury reached almost 5%. And I think they went into a panic. They were already worried about the Fed, that having the Fed funds rate at 5.5% and stay high or higher for longer. And they decided to try to ease financial condition by using debt management, that as we point out in the paper, is an indirect form of QE. 

And by the way, Treasury does not deny that what they’re doing has an impact on bond yields and on financial condition. They claim that it was not done for political reasons, but there is no other explanation of why they’re done it. Really, if it walks like a duck and it quacks like a duck, it must be a duck. 

And I think that they tried to ease financial condition because they were worried about a softish landing, a short and shallow recession, or a harder landing. And since the Fed was committed to keep the Fed funds rate high or higher for longer, it became a backdoor form of essentially easing financial condition and boosting the economy. At the time, however, Growth was strong, inflation was too high, and that was not necessary.  

Stephen Miran 

And so if you compare this to what happened during the COVID experience. During COVID, in the first quarter, in the first few months of the recession, Treasury issued two and a half trillion dollars of bills. Which is totally orthodox debt management policy. You have a real crisis. You issue a lot of bills to fund the government. You don’t issue a ton of coupons during the crisis. The Papers Act is implemented, which I participated a little bit in, and the economy starts recovering. Things are okay. In July of 2020, so a mere four months later, Treasury allows bills to start redeeming and starts terming those out into longer term debt. 

So net bills issuance goes negative in July of 2020, and it stays negative until October of 2021. So, five quarters, well over a year, Treasury allows the excess bills to redeem themselves and turn those into longer term debt. That’s orthodox debt management policy. You borrow bills in a crisis and then you turn them out when things are calmer. 

Last year we had a spike in financing needs as the debt limit was suspended and Treasury had to rebuild its savings accounts. It borrows in bills. But then, over a year later, we’re still borrowing excessively in bills. We didn’t wait three months and then started terming them out. We’re still borrowing excessively in bills. 

And unlike COVID, there is no financial crisis. There is no economic growth crisis. There is no market fragility crisis. Everything is pretty great. And we’re still engaging in emergency measures as if we’re in a genuine emergency. And we’re not.   

Jose Torres 

Steve Miran, one word you mentioned earlier was volatility. 

Steve Sosnick here is a big volatility guy. We work for Interactive Brokers, a huge pioneer in options trading and volatility and all that great stuff. Now, Nouriel, we’ve sort of become allergic to recessions, allergic to economic shocks, allergic to volatility. Seems that we want to quell things more than ever. 

Every recession, every crisis, there’s more added to the balance sheet, more extreme measures, bringing rates to zero, ballooning the balance sheet to nine trillion. Now we’re doing the treasury bills as a much issuance. What’s going to happen when we actually have a recession. What are our tools then? 

Nouriel Roubini 

That’s a very valid point. In some sense, we’ve used most of the bullets. Both on the monetary side and on the fiscal side, the deficit is huge, public debt as a shared GDP is high and rising, the balance sheet of the Fed, by the way, in spite of the current, quantity tightening, is significant, trillions of dollars above what it was before COVID. 

And therefore, as you suggest, if there was another recession, can we increase further the balance sheet by trillions of dollars? Can we start running much larger fiscal deficits? I think that the risk is one. That the bond vigilantes are going to wake up, are going to say, this is not sustainable on the fiscal side. 

And if instead you’re trying to keep a lead on rates by doing them, again, amounts of QE, you could have some unhinging of inflation expectations. So either the debt becomes less sustainable, or bond yields are much higher. If that doesn’t happen by monetizing it, you’re going to affect inflation and inflation expectation. 

So definitely, while this policy might have been needed during the global financial crisis, QE continued until we started to reverse and normalize rates for almost a decade, until about 2017. And then during COVID, we doubled down on the same thing. So, we are effectively running out of bullets. 

That’s absolutely an important and valid point.  

Jose Torres 

So, what about stocks? Last year, we had a great year, despite the monetary policy tightening that went on. This year, we had some hiccups recently, but we’re still having a relatively good year. Up 13% year to date on the S&P 500. 

Still in August. Survived the carry trade. Steve Sosnick survived the VIX going to 65, somewhere around there. Where do stocks go from here? Some folks feel like we’re front loaded. We’re going to be sort of flat for a while. Other folks feel like we can keep running. And other folks think we can have a really sharp correction. 

Stephen Miran 

Well, it’s important to note that our paper doesn’t make predictions about the stock market. What it does do is help us understand why the stock market has not collapsed in the face of an extremely aggressive Fed tightening cycle. And if you go back five years ago to before the pandemic, and you told people that, “Hey, the Fed was going to hike 500 plus basis points and do a QT.”, most people will probably say, hey, it probably means there’s going to be a huge financial crisis. 

And that hasn’t happened, I think, to a lot of people’s surprise. And when, and we think that these innovative issuance strategies designed to loosen financial conditions from the Treasury Department help explain part of the reason why. This nullified, this has stood in the way of a portion of the Fed’s tightening cycle to make it so that financial conditions are not as tight as they otherwise would be. So, we think that this helps explain why stocks have been so strong over the last year or so. They don’t really make a strong prediction for where stocks are going to be going in the near future. 

Nouriel Roubini 

I would add, however, that if the next administration, it doesn’t matter whether it’s Trump or Harris is going to win the election. If there were to term out this policy, then the additional issuance of long term bonds and less of bills that will be needed to go back to the previous ratios, in our estimate would imply that the 10 year treasury yield would go up by about basis points for at least two or three years, at the time where maybe the Fed is now starting to cut rates because the financial conditions have been tight for long enough. 

That they are willing to do so, and that could have a potential impact on equity prices could have also an impact on the economy. In an extreme case, if the Fed is easing while the undoing of this ATI implies 50 basis points higher loan rates, the economy could stall or tip into a recession, whether it’s short and shallow or more severe to be discussed. 

But there’ll be a cost to undoing this policy. Or if whichever administration is in power and they said they do not want to pay this cost, then this policy that was temporary, maybe before an election year, could become permanent. And if it were to become permanent, then the risk is, again, that the inflation expectation, you have eventually higher long rates. 

was expected than actual inflation is higher. So, in some sense, given what has been done now, the costs are going to be significant whether you continue the policy or whether you’re going to phase it out.  

Jose Torres 

My last question is, any optimal solutions for policymakers at this juncture? Obviously, cutting spending isn’t a popular thing to do, neither is raising taxes.  

Stephen Miran  

Well, you’re suggesting that the country should find its way to a long-term fiscal sustainability. 

Which is, which is very much optimal, but in the very near term, at least, not too likely, as you say. With respect to specifically the debt management stuff one point that we make, and that really is sort of one of the larger points of our paper, is that one has to pay attention not just to what the Fed or Treasury are doing in isolation, but to conceive of this as an overall policy portfolio. 

And think about the Fed Treasury consolidated balance sheet as moving markets. You can’t look at what the left hand is doing without also looking at what the right hand is doing. You have to sort of think about what they’re both doing at the same time. And it would be best for Treasury to return to regular and predictable issuance as quickly as possible and to return to orthodox issuance policy and determine that debt as quickly as possible. 

And if that ends up tightening financial conditions in a way that makes it more difficult for the Fed to achieve its mandates, The Fed can offset that by adjusting interest rate policy. And if it turns that, if it turns out the financial conditions tighten too much because treasury creates a significant backup in the long end of the yield current, the Fed can address that by loosening policy at the front end or adjusting its balance sheet policies elsewhere, each organ should be paying attention to its own mandates rather than trying to get involved in the activities of the other organs. 

So we think that it is important to return to more orthodox policies as quickly as possible. And we think that investors, policymakers, academics, everyone really needs to be paying attention to what the left hand and the right hand are doing, and make sure that one isn’t undoing what the other is doing. 

Steve Sosnick 

So Steve Miran, if, if Dr. Yellen happened to join this call right now, would your last discussion be basically your elevator pitch to her?  

Stephen Miran 

I think that she would prefer not to discuss the issue at all. She, their view, Treasury’s view. is that they’re not doing anything out of the ordinary, that their effects don’t, they don’t dispute our claims that their choices are affecting markets, but they maintain that they’re not affecting markets in a way that counteracts what the Fed is doing. And I think that they just wish that we would just go away. So, I think she would prefer to get out of the elevator as quickly as she could.  

Steve Sosnick 

By the way, if I may. Economists, as the non-economist on the call, economists get a bad name for being gloomy. And I will say, in my time knowing economists, the first one I got to know was the late Dr. Kaufman. When I was at Salomon Brothers and I was friendly with his son, my next-door neighbor, who I won’t throw under the bus as an economist, he’s a really nice guy, but he’s been known for making gloomy calls. It, it, how much of it, Can you push back here and just say that this is just adding realism to it? Rather than taking a glass half empty view of the world, I think it’s just being realistic, isn’t it? 

Nouriel Roubini 

Well, you know, Dr. Kaufman was the first Dr. Doom and then during the global financial crisis, yeah, I became Dr. Doom. I earned the title, so I’m the new Dr. Doom, but I usually say I’m not Dr. Doom, I’m Dr. Realist. You have to think about what are the downsides, and what are the upsides? And there are plenty of downsides and plenty of upsides. 

And the upsides actually have all to do with having the right economic policies. Because I wrote the whole book, Mega Threats, about the things that can go wrong. But for every threat and for every crisis, there is a policy solution. These policy solutions, however, require cost and sacrifices in the short run for the common good nationally and globally over the medium long term. 

And unfortunately, whether you’re in a democracy or an authoritarian regime, it’s very hard to make policy changes or structural reform that give us the benefits over time. And I wrote a whole book about political cycles in the macroeconomy and how, regardless whether you set the rights of the left, you try to boost the economy before the election, how both sides can try to manipulate or attempt to manipulate the independence of central banks, on how there are partisan divisions. 

Democrats like to spend, but they are willing or unable to raise taxes enough. Republicans like to cut taxes, but they are unable or unwilling to cut spending enough. And therefore, we have these structural biases towards fiscal deficits and then we have an electoral business cycle as well. 

Unfortunately, those biases imply that politicians look only about being popular or being reelected. They don’t think about the medium long term. And unfortunately, we’re on an unsustainable fiscal path. And our policy on the monetary side, they’ve been essentially monetizing fiscal deficits in a way that eventually could become inflationary over the medium, long term. 

So that’s realistic, it’s not the “doomish”, but the realistic assessment of where we are, unfortunately.  

Steve Sosnick 

And I guess the final question that I have for you guys is, last week at this time, we’re taping this, by the way, Monday the 12th, so last week at this time, the markets were in a tizzy and I won’t bore either you guys or the listeners, but I believe it was much more the effect of the carry trade and some volatility trades blowing up rather than the recessionary call. 

But there were some people sort of pants on fire, we need to cut rates immediately and cut them quickly. One of them was my former professor, so I really don’t want to throw him under the bus, but I was a little dismayed at that. What do you think the right policy prescription is for the Fed? It seems to me that the rate cut picture is, especially after your paper, is much more murky than it seems. 

Do you, what is your just general gut feel? How aggressively does the Fed need to cut rates, if at all?  

Stephen Miran 

So, I don’t know, I mean, it’s impossible that Nouriel and I disagree on this. Question from my perspective, and I’m happy to let him get his also, but from my perspective, there is an argument for some adjustment cuts, given the move in the unemployment rate, as well as inflation has come down a little bit. 

I don’t think the size of the adjustment cuts that we need is enormous. And I think that the adjustment cuts have already in large part been provided by the treasury department through ATI. There was an argument for adjustment cuts earlier this year. It just so happens that those adjustment cuts were delivered in the form of reduced term premium and reduced tenure yields rather than reductions in the overnight rate. So, my perspective is that inflation still ran quite high in the first half, 3.3% core PCE inflation in the first half of the year, GDP growth is, was 2.8% in the second quarter. The Atlanta Fed now cast is around 2.9% for the third quarter. 

And it’s still early in the quarter, but that’s still quite high. I’m far from convinced that, that the inflationary demon is truly slain and durably slain. And so, while I do think there is some scope for some adjustment cuts, some insurance driven reductions to the Fed’s policy rate, I think we need to incorporate the stimulus that’s been provided through treasuries, activist treasury issuance, but perhaps Nouriel has different views on, on inflation and unemployment than I do. 

Steve Sosnick 

Please share.  

Nouriel Roubini 

I’ll only point out that as Steve Sosnick pointed out, the unraveling of the carry trade. In the end, we’re driven by the fact that the DOJ decided, not fully unexpected, to raise a little bit another 15-basis points policy rate and cut its QE by half over the next couple of years. 

They’re still doing, by the way, QE, just at the later, there’s a tapering of their QE. And that led to a massive market shock that became global, together, of course, with some concerns about the U.S. economic growth stalling. But I would agree. The volatility was driven by this unwinding of the carry trade. 

But that implies that, you remember, in 2013, when the Fed started to talk about tapering, there was a taper tantrum. And this time around, there was another taper tantrum coming from the BOJ. Now, suppose next year, whoever’s in power decides to term out this issue. We think that the markets are not fully aware of the impact that this policy has had on yields and on asset prices. So, there could be a market shock. Now Steve correctly points out that, if that market shock were to occur, then the Fed can always ease more to undo it. But there’s, we point out treasury and the Fed have different roles. The Fed is in charge of the business cycle, dual mandate on growth, Employment and Inflation. 

Fiscal policy is supposed to do what fiscal policy does, decided by elected officials and so on. Fiscal policy has a role in the business cycle only when there is a recession, of course. You want to do counter cyclical fiscal stimulus. But it’s not the job of the Treasury to affect financial condition by using actively Essentially, debt management to do so, because that interferes with monetary policy. 

Unfortunately, in the last decade, As we’ve gone to unconventional fiscal monetary policies and credit policy, totally unconventional ones, the distinction between fiscal policy, semi fiscal, monetary and credit policy, has been blurred in a way that has risks over the long term, especially in a world in which the larger deficits that have to be eventually monetized that can lead to really unraveling of inflation expectations. 

So, we’re playing a bit of a dangerous game, and we are not realizing that these policies have long term consequences with meaningful negative side effects.  

Jose Torres 

Yeah, and it seems that the um, the bar for the inflation doves has been really low, at a low 4%. The CPI this week is expected to come in right at 3%. The folks have been pretty happy with that Nouriel, Steve Miran, Steve Sosnick. Folks have been cheering disinflation for the whole year, even though in many short-term periods when you annualize those figures, well above central bank targets, not just stateside, but all over the world.  

Thank you so much, Steve Miran and Nouriel Roubini of Hudson Bay Capital, Steve Sosnick, my co-host here at Interactive Brokers. I’m Jose Torres. Please like this podcast, subscribe, and feel free to check out our other ones. Thank you.  

Steve Sosnick 

Thank you so much. 

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