'Terrorist' economy: Washington is prepared to create a new financial disaster for the whole world
By newseditors // 2023-11-10
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There is a mantra that has essentially become axiomatic: the US Treasury market is the deepest and most liquid in the world. And a corollary to that is: US Treasury bonds are ‘risk free.’
(Article republished from RT.com)
These once-taken-for-granted pillars of eternal truth are looking awfully shaky. The tectonic plates of the US-led global financial system have been rustling ever more frequently in recent years but the quivers are now coming more frequently. At the heart of this increasingly brittle and dysfunctional system is the US Treasury market.
Everyone has noticed the sharp rise in yields in recent months. In early October, the US 10y hit a yield of nearly 5%, the highest level in 16 years. This is, of course, entirely understandable: rate hikes by the Federal Reserve have pushed bond yields higher. But what we have been seeing is more than a manifestation of the vicissitudes of finicky markets.
As foreign buyers of US Treasuries dry up and the US government continues to run astronomical deficits at a time of high interest rates, the Treasury market is coming under increasing strain and showing ever more signs of dysfunction. The implications of this are hard to overstate.
Incidentally, it was also 2014 when problems with Treasury market liquidity first began to draw scrutiny. In October of that year, the market convulsed with no apparent trigger in what ended up being dismissed as merely a “flash rally.”
There have been several other significant convulsions along the way – the sudden repo crisis in September 2019, the Treasury market seizing up in March 2022, and the UK Gilt market breaking in the fall of 2022, which reverberated in the Treasury market, but we’ll fast-forward to 2022.
The nastiest bout of inflation in four decades had forced the Fed to sharply hike rates. The higher interest rates pushed bond yields up, and since bond prices move inversely with yields, US Treasuries took losses. Many US banks became deeply underwater on their Treasury positions, a fact that played no small role in the collapse of Silicon Valley Bank earlier this year. There were many specific reasons why that particular bank collapsed – practically non-existent risk management being one of them – but what that episode revealed is that many banks were sitting on large unrealized losses in their Treasury positions.
As depositors demanded their money back – both for fear of bank failures and in order to place their money in higher-yielding money market funds – banks would have had to sell their underwater Treasuries into a rapidly deteriorating market, where bids would have been few.
However, undoubtedly sensing the fragility of the entire system and not wanting a full-blown meltdown on their watch, Fed Chair Jerome Powell and colleagues decided to act – and they acted decisively.
Meanwhile, more recently another firm step in the direction of yield curve control was taken when the US Treasury announced that it would be launching a buyback program next year. Somewhere along the way in the slow descent of the US Treasury market into illiquidity and dysfunction we were bound to see direct Treasury purchases of debt that nobody in the market wants to buy – and now we have it.
This tool hasn’t been trotted out since the year 2000, when it was done under very different circumstances (the government was running a surplus and was issuing Treasuries to maintain market access, with the proceeds from the new bonds used to repurchase the old ones).
Now, however, this is being done, according to comments by one Treasury Department official at a forum in New York in September to “[help] to make the Treasury market more liquid and resilient” and in a bit of cheery party-line speak, “to ensure that the Treasury market remains the deepest and most liquid market in the world.” Statements such as these made in a casual business-as-usual way and presented as a small maintenance program that will not be used to combat a potential crisis belie just how much this represents another “crossing of the Rubicon.”
If you unpack this, it means that the Treasury is preparing for the possibility that there won’t be enough buyers for the avalanche of issuance that will be hitting the market in the coming quarters. By announcing a buyback program, the Treasury is essentially laying the groundwork to become the ‘buyer of last resort’ without stating so explicitly, which would of course spook the markets. It is also pretty much exactly what Japan has been doing for the last decade or so – essentially nationalizing the debt that nobody wants.
Legendary analyst Zoltan Pozsar has described what we’re seeing as the Fed and Treasury “building scaffolding around the Treasury market” to deal with issues of illiquidity and the lack of a marginal buyer. The question that can’t be asked but needs to be asked is: why is all this necessary in the deepest, safest and most liquid market in the world?
The government is spending like there’s no tomorrow
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