Darrell Duffie On How to Fix the World’s Most Important Market

Tracy Alloway (0:10)

Hello, and welcome to another episode of the Odd Lots Podcast. I'm Tracy Alloway.

Joe Weisenthal (0:15)

And I'm Joe Weisenthal.

Tracy Alloway (0:16)

Joe, have you been watching Treasury Yields lately?

Joe Weisenthal (0:19)

They're up. They've gone, they, I'm aware.

Tracy Alloway (0:22)

That's the show.

Joe Weisenthal (0:22)

I'm aware that the line has gone up and to the right lately.

Tracy Alloway (0:25)

Yes, but not just that, they've moved quite quickly up. And I think volatility in the Treasury market has once again become a talking point. And I always get a little bit of a sense of deja vu, because whenever things start happening in the market for US government bonds, extreme things, these extreme moves, it feels like everyone says, oh, this shouldn't be happening. In the world's most liquid market, the world's safest market, we shouldn't be seeing these types of dramatic shifts.

Joe Weisenthal (0:53)

Right. The expectation is this is like a very extremely liquid, slow moving market, but it has been a very fast move. And people don't really know why. There's a lot of debate. You have people talk about, well, look, the economy is proving to be more resilient than people might have guessed six months ago, even a month ago.

And I think there's this sense that things are moving faster. There's also a lot of talk about Treasury supply, supply demand, and balances, and so forth. So things are on the move, to say the least. And you see it in mortgage spreads are very wide. You see it in other risk assets not seeming to like this Treasury volatility. So lots going on there.

Tracy Alloway (1:31)

So you mentioned a couple things there, which is, yes, the economy seems to be doing relatively well, and yes, the amount of Treasury supply is exploding and has been going up for a very long time. There's another factor here, which is the actual inner workings of the Treasury market, so how Treasuries are actually traded and whether or not that is potentially contributing to some of the volatility that we've seen. And again, I feel like this topic keeps coming up. Every year, there's some massive move in Treasury markets.

And everyone starts talking about liquidity issues.

And yet, you don't really see any big solutions being proposed to it. You talk about maybe loosening some of the regulation around the supplementary leverage ratio or something like that. But it feels like we need to talk about this and maybe try to come up with a solution. Let's do it.

Joe Weisenthal (2:21)

And we're in a good place to talk about it.

Tracy Alloway (2:22)

Yes. We are at Jackson Hole.

Joe Weisenthal (2:25)

I thought that was going to be the first. That is, we're at Jackson Hole. I like how we eased into it a little bit.

Tracy Alloway (2:30)

Oh, I want this to be an evergreen episode for an evergreen problem, it feels like.

Joe Weisenthal (2:35)

But the people here care about this topic.

Tracy Alloway (2:37)

Yes, absolutely.

The way US Treasury debt is traded has a lot of implications, particularly for the cost of financing the US deficit. That's an obvious one. And so we should talk about it.

Joe Weisenthal (2:50)

Let's talk about it.

Tracy Alloway (2:51)

I am very pleased to say that we have the perfect guest. We are going to be speaking with Darrell Duffie. He is, of course, a professor of finance at Stanford's graduate school of business. And he is presenting a paper at Jackson Hole, in front of the world's top central bankers, all about this issue. It's called Resilience Redux in the US Treasury Market. So Darrell, thank you so much for coming on Odd Lots.

Darrell Duffie (3:14)

Thanks for having me, Tracy, Joe. It's terrific to be here.

Joe Weisenthal (3:17)

You know it's the perfect guest when it's the guest. It's like not just like we want to have them on Odd Lots, that the top central bankers around the world want to hear from Professor Duffie. So yes, I'm very excited about this episode.

Tracy Alloway (3:30)

When treasuries are moving, they call up Darrell Duffie.

Well, Professor, thank you again for coming on.

Why don't we just start with the basics? We sort of alluded to this in the intro, but it feels like this is a subject that just keeps coming up and never really seems to go away. What's going on here?

Darrell Duffie (3:48)

Well, over the past century, there have been, as you suggested, many episodes of increased volatility and liquidity problems in the Treasury market, but I do think these are happening more frequently. Just recently, I think you summarized pretty well some of the stresses in the Treasury market coming from the fiscal side. The US is issuing more than people expected.