The Biggest Carry Trade In The World by David Schawel, Economic Musings
By now, everyone knows that the Fed hiked rates yesterday. What most people don’t realize though is that the economics of the “biggest carry trade in the world” has now changed. To review, when the Fed purchased bonds they paid for them with newly created reserves which sit at banks earning IOR (interest on reserves). So before yesterday, the Fed was receiving interest on the bonds that they purchased (US Treasuries & Agency MBS), while paying out 25bps to banks on the corresponding reserves. Simply put this is/was a multi trillion dollar carry trade, borrowing in the overnight market (paying IOR to banks) while earning the yield on the longer maturity bonds that they purchased.
Starting today, the economics of this trade changed. Now the Fed is paying 50bps for IOR, while the yield on the bonds they’ve purchased is unchanged. At the margin, this is a positive stimulus for the private market with 50bps being paid on reserves instead of 25bps. I’ve always said that I believe this “carry trade” is disinflationary at the margin as the private sector does not earn the income on the bonds. Starting today this “margin” the Fed is earning is less. Does this have massive implications? No, as this “carry” is still very profitable as the Fed is essentially borrowing at 50bps and earning well in excess of that on their average holding. At the margin though, this is an additional 25bps being earned by the private sector on multiple trillion of reserves. This is stimulative for the private sector.
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