TD Securities: Unearthing The Mystery Long-End Bid

TD Securities note that “strong economic data and a hawkish Fed have led the front end to reprice sharply, but long end rates remain stubbornly low amid a decline in the implied terminal rate and term premium. The market is pricing a terminal Fed rate of only 1.4% - lower than the 2% implied in March 2021 and the Fed's 2.5% long run dot. There is a global dimension to this move as many developed bond markets are reflecting a similar dynamic.”

• They “struggle with the Fed "policy mistake narrative" since financial conditions are very accommodative. In addition, unprecedented fiscal support likely prevented labor market scarring.” They think “strong demand for longer-dated Treasuries is behind the relentless flattening of the curve, near record low real rates, and the widening in swap spreads,” and believe that “the biggest buyers are banks, pensions, and China.”
• “U.S. banks have been significant buyers of Treasuries recently. Banks have bought $219bn since September, compared with $205bn from January to August. The buying is a function of growing excess reserves - a by-product of QE. While banks tend to buy 2- to 7-Year paper, greater usage of HTM portfolios suggests that longer-dated Treasuries were likely also bought.”
• “As the funded status of pensions has improved, pension risk transfer trades (PRT) have increased sharply. PRT results in demand for Treasuries as insurance companies immunize pension portfolios by extending asset duration.”
• Earlier this year they argued that “China has been intervening via their state banks and believe that trend has continued. Intervention dollars would likely be reinvested into Treasuries.”
• “With the Fed set to accelerate tapering and end QE by March, some of these dynamics are set to change. Excess reserves in the banking system will decline in 2022, reducing bank demand for Treasuries.” While pension demand and Chinese intervention may continue, they don't expect them to increase buying. Thus, they believe that “longer dated rates should rise and Treasuries should cheapen to OIS or SOFR.”