Globally, the banking sector has gone from too much uninvested cash, to probably about right. (We don’t have time here to revisit the recent elaborate game of chicken over the debt ceiling. Notice I said “elaborate” and not “elegant.”) Incremental spreads on bonds will tend to widen as rates fall, as lower yields accompany an economy that is losing momentum. This slowdown brings with it a higher likelihood of debt service problems, so lenders, including bond investors, ask for additional yield protection. In 2023, there’s no slowdown, yet, and so the FOMC has now hiked overnight rates to their highest levels in 15 years in its quest to get inflation under control. And still, spreads are wider in virtually all bond sectors, so something different is in play. One factor is the Fed’s posturing related to its own balance sheet. Currently, the Fed is removing $95 billion per month from its own Treasury inventory. It has reserved the right to actually shed some of its $2.5 trillion MBS portfolio, but hasn’t yet. Another difference this time around is the welldocumented decline in excess liquidity on bank balance sheets, which I hasten to add is not the same thing as deposit runoff. Globally, the banking sector has gone from too much uninvested cash, to probably about right. Again, this has removed some demand from the fixedincome markets as the banking sector has purchased very few bonds in 2023. Some Sectors Are Not Like Others The callable agency market gives us a good example of how spreads are historically wide. Way back in 2021 (hyperbole), a bond that matured in three years and 15 The CommunityBanker
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