Well, it's official. The Federal Reserve announced this morning that the exemption to its supplementary leverage ratio (SLR) that was implemented on May 15, 2020 would expire, as scheduled, on March 31st. Treasury bond yields spiked on the news as the yield on the 10-year UST went from a pre-announcement level of 1.68% to 1.72%. This, combined with the fact that today sees a "quadruple witching" expiration combination (which happens on the third Friday of the last month of every quarter,) should ensure a volatile day in the equities markets. I trade options, so volatility is generally good for me... and so is Jerome Powell. His decision to go "footloose" on the SLR exemption has confirmed his position as the Kevin Bacon of the financial markets.
Yes, as the "six degrees" game would indicate, Kevin has had many roles, but here I am focused on his early career appearance in Animal House. As Kevin's character is trampled by a fleeing mob of Faberians and continues to insist "remain calm, there is nothing to see here", so too are Powell and his cronies at the FOMC equally oblivious to actual facts.
From this morning's Fed press release:
To ease strains in the Treasury market resulting from the Covid-19 pandemic and to promote lending to households and businesses, the Board temporarily modified the SLR last year to exclude U.S. Treasury securities and central bank reserves. Since that time, the Treasury market has stabilized.
Ah, Okay, the Treasury market has "stabilized". This chart from the St Louis Fed's excellent FRED database, like an old friend, is quite reliable and shows that nothing could be further from the truth. The bond markets are crashing. On the first trading day of 2021 the yield on the 10-year UST note was 0.93% and now it is 1.72%. There is something to see here.
We are headed to 2% with a bullet, in terms of the yield on the 10-year UST, and I am just not sure the meme-driven "stonk" market of high-flying names (most in tech, although GameStop (GME) hardly fits that moniker) that we have in 2021 can handle this.
In the time of writing these five paragraphs, the yield on the 10-year went from 1.72% to 1.74%. This is heady stuff. How to play it? In a prior RM column I analyzed the many flavors of long/leveraged-long/short/leveraged-short U.S. Treasury ETFs, so I won't belabor that here. I will draw the curtains, just for a moment, though, and tell you what I am doing.
I am short (TLT) (which owns long-dated U.S. Treasuries) and used the instant proceeds from that short sale to go long (TTT) , which is 3x SHORT long-dated U.S. Treasuries. That's a little confusing, but, needless to say, it's a bet that Treasury prices will continue to fall and yields will continue to rise. It's a directional bet. Those are my favorites. I also have weekly call options on TTT - so they rise in value when Treasury prices fall/yields rise - and I better get back to managing that position, so I will wrap it up here.
Like everything else in today's "stonk" market, SLR was important for sentiment. The SLR exemption only applied to the largest of banks and every single one of them is well above required levels of capital, whether the SLR exemption is made or not. But, at the margin, the removal of the SLR exemption - which excluded banks' holdings in Treasuries and deposits at Federal Reserve banks from required reserve levels - is seen as contractionary. As I noted in a prior RM column it is a perfect protection against the Crash...of 1929. In 2021, it is just background noise...in a bond market that was already pretty noisy to begin with. Make sure you are listening.
