Chart of the Month
Over the past year there has been an animated debate concerning the 30-year downtrend in long-term US Treasury bond yields: has the trend been broken and should we expect higher yields in future? Elevated nominal GDP growth in 2018, coupled with the Fed’s quantitative tightening and the additional primary debt issuance (to fund annual US deficits of more than a trillion Dollars in the next decade), suggest that long-term rates should rise. According to the NY Fed, There has been a significant increase in primary dealers’ inventories of US Treasuries in the second half of last year. If interest rates start to rise again in the coming months, will this increase be reversed?
The chart shows a significant divergence in the deposit-to-loan ratios between small and large US banks since 2012. Small banks, defined as those with assets lower than US$10bn, have been active in the lending market over the past decade but have been outbid for deposits, failing to raise interest rates on savings fast enough relative to the large banks in this period of monetary policy tightening. However, the depletion of excess reserves is a headache for reserve-rich large banks, not reserve-poor small ones. Also, as the credit cycle moves towards its maturity, risk tends to concentrate in the hands of the large banks.
The Chinese government is taking great pains to woo overseas investors to its $5trn sovereign bond market, allowing block trades, improving the settlement process and introducing new tax breaks prior to inclusion in a major bond index next April. Whereas international ownership of the US Treasury may have peaked, foreigners own only 2 per cent of Chinese sovereign bonds. The closing of the yield gap is in sight as the PBoC steps up its lending to commercial banks, enabling them to increase their domestic bond holdings.
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