If the world is poised upon the precipice of “deflation” and the ugly economic consequences of reduced “money supply”, at the middle of all that are the primary dealers – still. While it is technically correct to claim that the Fed expanded its balance sheet to $4.5 trillion, with $2.4 trillion left after autonomous factors for bank “reserves”, that actually means very little without almost perfect assistance of the primary dealers. The idea of QE was that buying securities from these dealers would leave them no choice but to turn around and use some of those reserves in either money markets further on, or in outright purchasing of other risky securities. And if those reserves were further offered into money markets, such cheapening rates would spark the tide of risk taking or some forsaken “animal spirits.”

Dealers, for their part, don’t really make money from holding securities; in fact, no financial institution does as spreads are simply too thin. The wholesale world is a leveraged world, leaving leverage in all its forms as the basis of both liquidity and derivative math-as-money. We can only infer leverage available through certain opaque and imperfect windows. One of those is primary dealer holdings of UST coupons.

Conventionally, commentary assigns dealer holdings as they would any other portfolio, as speculative trade – as in recently “short” UST bonds on the expectations that the Fed would hike rates (and further that any rate hike would actually matter for something). While that might play a role in some settings, overall it doesn’t affect dealer holdings in that way. Here are the latest figures for what primary dealers reported in their coupon inventories:

From the purely investment standpoint, it wouldn’t make sense that dealers are in the aggregate net short the 10-year (in the 7-11 reporting bucket) but long the outer maturities. Likewise, why would dealers be net short 2-3 years but long 2 years and less? The reasons for holding patterns like this have nothing to do with interest rates or even monetary policy as it is generally understood. These are technical factors that relate to UST’s and primary dealers as major collateral conduits.

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