A Dubious Milestone

Posted on September 26, 2018 by Gemmer Asset

Last week we wrote a piece on what has changed since Lehman’s failure. A key point we tried to make (read more here) was both banks and consumers had paid down debt (deleveraged) while the U.S. government had taken up the slack. Debt to GDP in the United States is on track to surpass the level last seen during the New Deal/World War II years, as you can see below.

 

 

On this point, we hit a dubious (albeit somewhat arbitrary) milestone this week. For the first time ever, the U.S. government will issue over $1 trillion of debt in September. A trillion here and a trillion there and pretty soon…

 

Now the $1 trillion number for a single month is a little misleading. Some of this is going to refinance maturing debt. It’s not all new debt. But a lot of it is due to the tax cuts and higher defense spending. Another way to look at it is how much new debt has been issued this year. Again, about $1 trillion, as you can see below.

 

 

Roughly half of this new debt is in T-Bills – securities with maturities less than one year. This will naturally increase the government’s interest costs over the coming year if the Fed continues on its path of rate hikes.

 

All of this comes at the same time the Fed is reducing the size of their balance sheet (quantitative tightening). This essentially means selling both government and mortgage bonds it holds on its balance sheet back into the private marketplace. So far, they have sold off about $145bn this year. This adds to the amount of bonds the market has to absorb.

 

Basic economics implies that more supply hitting the market (in this case the supply of government bonds), the lower the price. A lower price for a bond means a higher yield.

 

The $64 trillion dollar question for the markets over coming months and quarters is what will be the impact on the markets from this massive Treasury bond issuance combined with quantitative tightening? The bonds will be sold at some price, but two key questions loom:

 

  1. How low of a price (high of a yield) will be needed to entice buyers?
  2. What gets crowded out? Is there enough global savings to go around to fund both massive Treasury issuance and the funding demands of other entities? For example, will Argentina be able to sell debt at anywhere near reasonable yields to fund operations, or will they face a funding crisis? On this point there are already mutterings of discontent

 

 

 

 

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