A question on how Central bank manipulate Treasury bill and yield

sarahchimp's picture
Rank: Monkey | 52

I am wondering about how Fed/government manipulate the Treasury bills. Since I read news that Fed stimulate the economy through buying bonds, which provide liquidty to market. On the other side, central bank also issue new Treasury bills to borrow money, which form huge indebtness.

I am so confused that in the first method, yields are generally lower since more demand on bond; while in the second one, this should lead to a higher yield again? Doesnt it contradict with their own behavior for regulating market?

Who could help me, and I know it's silly question.

Comments (9)

Apr 2, 2020

Is this a possible explanation: they are buying long term bonds and sell short term bills? I am confused

Apr 2, 2020

They are two separate two things. Treasury is the government, Fed is not the government. Treasury will issue debt (bills, notes, bonds, etc.) on behalf of the US government. The Fed is independent which sets monetary policy in the US and doesn't issue anything. Fed is buying what the Treasury issues which theoretically sets a floor for their price aka QE.

When "manipulating" I guess you are speaking about how the Fed sets interest rates. The Fed doesn't just magically set interest rates, they have a trading desk which is based at the NY Fed which actually goes into the market to do operations in the money markets/repo which sets corresponding rates where they need to be. I believe the only rate they "set" is the discount window rate which is where certain banks can borrow money direct.

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Apr 2, 2020

Thank you Koalamacro. If I understand correctly, US government is borrowing money from Fed then, since Fed buys their Treasury issues. And Fed do this by printing money. So how does bond purchase (monetary stimulus) provide liquidity into market? Isnt it just a fiscal stimulua instead, since government is the one who gets money in the end, but not public.

Thank you

Most Helpful
Apr 2, 2020

Technically, it's "money supply" but yes it's basically printing money lol. Important to remember that fiscal is anything to do with the government (ex. taxes, budget, gov spending, etc.) and monetary (interest rate policy, QE, forward guidance, etc.) is anything to do with the Fed.

So when the Fed purchases bonds, they don't purchase it from the Treasury directly. They actually purchase it from primary dealers (aka banks), the same ones that participate in the Treasury's auctions. The thinking is if the Fed buys bonds from banks, then money supply / liquidity is provided to the broader market through the banks.

Whether this actually works has been the debate for the past two to three decades... In a perfect world, this new "money supply" would find its way to everyone and increase economic activity (business activity stimulated by banks providing capital to broader market to do things they might not have been able to do otherwise). Because the Fed is suppressing interest rates, businesses and individuals are also more likely to take risk (ideally through investment in the real economy).

While some of the intended effect has happened from QE, the most dominant effect has been raising asset prices (equities, real estate, etc.). Seems that money that was intended for investment has gone to just purchasing other assets...

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Apr 2, 2020

you are so helpful as I struggled to search online. May I also ask whom you think would eventually benefit from QE? Some article I read said the wealthy people, while I did not get it. And also some others said it finally led to higher interest rate/dollar devaluation.

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Apr 3, 2020

No problem, I enjoy answering these questions as a macro trader. So the easiest way to think about it is that only the wealthy tend to own assets (ex. stocks and real estate) and the only ones that will continue to buy them. The person living check to check , making $20 an hour will not be buying assets.

So I think what you mean by your second question... The immediate concern through supplying so much "money supply" is that inflation would eventually become rampant (a lot of people were worried about this back in 2008). As inflation rises, interest rates would have to rise to counter them. Clearly the inflation scenario did not happen as the Fed actually struggled to create it which has been the other main debate over the past decade. Nor did this happen in Japan which has basically been in QE since the early 1990s. The secondary concern would be that when the Fed eventually decides to unwind QE "taper", the market isn't able to take all of the bonds that they had originally bought. You might have heard of the "taper tantrum", but this was also quite short lived.

As for dollar devaluation, it's quite similar to the above. This also did not happen. More inflation or even more "money supply" should theoretically lead to a weaker currency as it's either worth less or there is more of it. I think this is where USD stance as the reserve currency in the world comes into play. You could even argue JPY hasn't really devalued to the extent that was feared - BoJ actually wants to keep it weak.

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Apr 3, 2020

So a higher interest rate could normally lead to stronger currency, since people tend to deposit money in that regional bank. While higher inflation rate leads to weaker currency like you said. Japan has both weak interest rate and weak currency, is that mainly because of their negative interest rate? since they have low inflation rate comparatively

Apr 4, 2020

At the most basic level, a country with a higher interest rate should encourage investment in that country as it offers a higher rate of return relative to other currencies which leads to more people buying that currency.You can see how USD rallied when the Fed first started on its rate hike cycle back in 2015-2016. Yes, so Japan has a weak currency because of central bank intervention (aka negative interest rates among other thing). They want to create inflation so they are purposely trying to keep their currency weak. You've probably heard the US Treasury calling them out before for "manipulating their currency". You'll see that everything in central banking and monetary policy is a balancing act.

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Apr 4, 2020
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