Despite the soaring Treasury yields, Federal Reserve (Fed) Chairman Jerome Powell did not say anything to reassure the market when he spoke last Friday. He said he did not think the way the Treasury yields were going was out of line, nor that they would push up long-term interest rates to a point where the Fed would have to take strong actions. To put it plainly, he believes that the current Treasury yields surge is not insane enough. Since he spoke, US 10-year bond yields have been hovering between 1.5 and 1.6 percent. At the time I wrote, the rate still stood high.

Powell stressed the need to maintain credit easing until the goal of maximum employment in the US is achieved. In recent years, the Fed has been emphasizing the need to wait for full employment to be achieved. This is because the Phillips curve model does not work anymore after a long period of the Fed using monetary policies to boost the market. Not long ago, the unemployment rate in the US hit a record low, and yet inflation still had not happened. So the Fed no longer depends upon the Philipps curve theory and instead gives top priority to full employment, followed by inflation, thus giving rise to the principle of putting up with an inflation rate of more than 2 percent.

In the near future, there are two periods worth paying attention to. The first is the period before August 1. As a result of recession last year, the US Department of Treasury raised funds by issuing a huge amount of bonds. As of the end of 2020, the balance of the department’s Treasury General Account (TGA) stood at US$1.6 trillion. The department expects that its TGA balance will have reduced to US$800 billion in March and US$500 billion in June. This is a plan, and the actual result may be a bit different. Due to US legal restrictions related to the debt ceiling, the balance of the Treasury Department’s TGA has to go down to US$200 billion on August 1.

This means the Treasury Department will get US$1.4 trillion out in the market before August 1, the monetary base in the US will expand, and M2 as well as bank reserves will increase. US short-term bonds issued last year accounted for 60 percent of the total amount. Therefore, a large chunk of the US$1.4 trillion will be used to repay the short-term bonds issued last year, and the yield of short-term bonds with a maturity of less than one year will fall again. Meanwhile, the department will have to draw up Joe Biden’s fiscal stimulus plan later and has to issue bonds. Consequently, short-term US bonds will fall and long-term bonds rise, making the yield curve upward. On the face of it, market liquidity is fairly abundant, but an approximately 2 percent yield of 10-year US bonds should be the tipping point.

The second period to take note of is the days leading up to March 31. Following the financial crisis in 2008, the US used the supplementary leverage ratio (SLR) to regulate the weight of banks’ risk assets. Last year amid the Covid-19 pandemic, banks were allowed to exempt any holdings in US Treasury debt or deposits at the Fed. The exemptions will stay in place until March 31 this year. In case the exemptions are not extended, given that the balance of the Treasury Department’s TGA will lead to an increase in bank reserves, banks will have to readjust the weight of their risk assets by such means as selling bonds and issuing preferred stocks, which will increase their capital. In short, the objective will be to attain the right leverage ratio of the weight of risk assets. This issue is relatively less important because part of it has been reflected in Treasury yields, and the chances of the exemptions being extended are high.

While the US is on a path towards inflation, oil price has risen after the attacks on Saudi Arabia’s oil facilities. Powell is making way for further increase in Treasury yields, while the US dollar, which the market has taken a bearish view on, has not fallen below the bottom line but is actually going up gradually. A momentum of the greenback making a comeback is quietly approaching.

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