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Today's Bullets:
The Announcement Breakdown
Deficit and Demand Reality
Treasury Competition
Hidden Gems
So…Buy Bonds?
Inspirational Tweet:
You may have noticed something strange about the attention of Wall Street this week. Specifically, the attention of investors and how it was snatched from the Fed by anothergovernment mouthpiece.
Even though it was Fed rate decision week.
What on earth could be more important than Fed rates these days?
Would you believe an announcement from the...US Treasury?
But, what could the Treasury announce that could possibly steal J-Pow (er, Jerome Powell)'s all-important rate decision thunder?
What kind of shiny object distraction did the Treasury razzle dazzle the investing world with, and was it little more than simple smoke and glitter?
Well, we're going to completely unpack and inspect the shine on this Treasury object, because we like to critically think around here at The Informationist.
But have no worry, we will do it nice and easy as always, today.
So, grab that cup of coffee, and get ready for some critical eye candy, as we check and chart out the Treasury's announcement from this week.
🤑 The Announcement Breakdown
With much attention and global investor fanfare, the US Treasury gave a peek into its expectations of the upcoming fourth quarter re-funding levels.
First, on Monday, the Treasury said it expects to borrow $776 billion in the fourth quarter, $76 billion less than its forecast in July, citing increased revenue estimates. This gave the market some confidence, heading into Wednesday's announcement.
This is when the Treasury gave insight into the strategy behind the quarterly refunding, including expected sizes and terms of debt securities it plans to auction.
The main thing that investors keyed in on here is the mix of offerings between short-term debt and longer term debt.
So, what did the Treasury say, and why was Wall Street instantly smitten?
The announcement of sizes and expected allocation changes to the longer end of the curve, was as follows:
As you can see, the Treasury said it expects to only increase the 3yr and 10yr Note auction by $2B each, and the 30yr by just $1B.
This got investors all but giddy, and immediately sent yields down and bond prices up across the board.
Why?
Because the Treasury is signaling that they expect borrowing needs to decrease this quarter, alleviating investors' fears that there will be a deluge of long-term debt issued to cover seemingly-endless increasing federal deficits.
So, the government will only have to borrow an expected $776 billion in the fourth quarter now.
Hooray?
Not to be a bond-party pooper, but we've been hearing all about the debt spiral (you all know I've been talking about it for over a year now) and federal debt has ballooned over $2T in the last few months. This announcement wasn't exactly ground-breaking or earth shattering. At least not to me.
So, is the market just smoking a large dose of hopium? Believing that fiscal wizard Janet Yellen has some sort of unknown monetary magic up her sleeve?
Let's travel back into the atmosphere for a minute and see, shall we?
🤨 Deficit and Demand Reality
To put it bluntly, if I were a journalist interviewing Janet about this plan and its validity, I would have knee-jerk reaction that may resemble something like Ron's here:
But is it just my distrust of the Treasury and the government and its relentless, reckless spending ways?
Or is there some concrete reasoning behind my knee-jerk reaction?
First off, let's take a peek into how the government is managing its spending this year.
When we add it all up and include the accounting gimmick of the student loan forgiveness, we see that the US budget gap (i.e., The Deficit) has doubled from last year.
That's right, and this may be why we have piled on so much debt this past few months.
Now, one of the main reasons for decreased expected borrowing needs, as the Treasury stated in their release, was "primarily due to projections of higher [tax] receipts which were somewhat offset by higher [government spending] outlays."
And so, we can take the Treasury at their word, or we can use some common sense.
Something they seem quite short of, recently.
Common sense says that we have some headwinds facing us in the near-term, both economically and fiscally.
First, we have a massive amount of USTs that are maturing and need to be re-funded to pay off the principal in the coming months. This is mostly due to the fact that the Treasury has been issuing shorter and shorter paper in order to meet the demands of the Congressional Spending Monster.
But the Treasury is well aware of this and is certainly planning accordingly. 🙄
That said, the Spending Monster seems to be continuing to go unchecked in Congress, and we still have an unreconciled federal budget issue that was delayed into this month.
Remember that?
Yeah, that showdown happens over the next two weeks.
Maybe that's why the Treasury itself even admitted, that the primary dealers (the banks that buy the debt and then pawn it off onto investors and institutions) "explicitly noted a high degree of uncertainty overall around deficit and growth forecasts, reinforcing Treasury’s need to maintain flexibility in their issuance strategy."
Interesting, and we will come back to that.
First, let's just recognize that the most recent economic data we have points to an economy that is slowing down, not heating up. And this means higher unemployment, lower corporate and individual earnings, and lower tax receipts.
Remember, the government is always looking backwards at data. They are not the best predictors of the future.
Exhibit A:
Bottom line, more unemployment means higher entitlement spending and lower tax receipts for the quarter (at least in estimated payments).
But let's dig further.
🥸 Treasury Competition
One first hole we ought to check out is the Fed's Quantitative Easing hole. That's right, the one where the Fed and Treasury teamed up to 'provide liquidity to the stressed market' buy its own bonds in 2020 and 2021.
What was that about no more financial crises in our lifetimes?
In any case, this put almost $6T of USTs and MBS (mortgage backed securities) on the Fed's books, something they have been trying to get rid of this past year.
And guess who else is selling USTs to shore up their own currency and debt market?
That's right, the largest foreign holder of USTs.
Japan.
So with the Fed trying to sell their USTs, and Japan and China selling theirs, we still have that nagging issue of something called risk premium and the bond vigilantes demanding them.
If you're wondering what I'm talking about here, I wrote all about bond vigilantes and risk premiums in a recent newsletter that you can find right here:
TL;DR: Bond investors demand higher premiums when they are uncertain about debt issuance and higher inflation.
Does that mean this is all nonsense and noise from the Treasury? That they have their heads in the sand regarding the economy?
Let's dig a bit further.
🧐 Hidden Gems
There were a couple of hidden gems that were in the Treasury's release that seemed to be almost completely ignored by the investment world last week.
The first one was a quote that read, "Treasury anticipates that one additional quarter of increases to coupon auction sizes will likely be needed beyond the increases announced today."
Call me crazy, but in one little sentence they gave themselves the ultimate Get Out of Jail Free card.
No limits.
No timing.
No insight to the possible allocation between short and long term issuance.
Just a we may need to issue more than we stated here disclaimer.
And Wall Street all but ignored it.
Not me. I wonder, how much and when? Which brings us to our next question: who the heck will be buying any of the increased issues?
We've seen what the market thinks of exploding debt levels, but the Treasury has made it clear that they are doing everything they can to manage expectations around that debt level, and keep it to a minimum, at least for the moment.
Which brings us to our next little gem, also gleamed from the belly of the release:
"Treasury continues to make significant progress on its plans to implement a regular buyback program in 2024. This last quarter, Treasury received important feedback from the primary dealers with regard to scheduling buyback operations for liquidity support and cash management purposes. "
Aha!
The Treasury is getting their ducks in order to enter the market and start buying USTs themselves.
Why?
Because the ability to issue short-term T-Bills will soon run out. And that has to do directly with this:
Hint: the Treasury has been issuing short-term paper to tease balances out of the Reverse Repo Facility, which is eligible for short term investments (T-Bills), but not long-term (i.e., 10 to 30yr bonds).
When that $1.1T number goes to zero, the T-Bill music stops and the Treasury has to issue longer term paper.
Which begs the question: When does it run out?
And the next question: What does the Treasury do when it does?
But they answered it, buried like a whisper in a dark alley: "[We] continue to make significant progress on its plans to implement a regular buyback program in 2024."
This is none other than yield curve control. The Treasury will be buying 'off the run' Treasuries to provide the much-needed liquidity that the primary dealers are seriously concerned about.
So maybe, just maybe, Wall Street isn't so crazy after all.
It looks (and sounds) like the Treasury is playing a high stakes game of chicken here.
Betting that tax receipts don't come in far below their models or suddenly plummet.
Hoping that the Congressional Spending Monster somehow finds religion and stops the DC madness.
Praying the economy doesn't suddenly plummet into a deep recession.
But if they do or if it does, the Treasury has a Yield Curve Control plan that is almost in place.
They just need to limp their way to 2024, before the bottom drops out.
🤓 So…Buy Bonds?
Seems to me there is little doubt that we are headed for an economic slowdown and likely a full-on recession.
With a recession comes lower tax receipts and higher entitlement spending. And if we send ourselves headlong into the war in the Middle East, well, then defense spending (further) balloons, too.
Deficits widen.
Debt explodes higher.
Interest rates will then rise or stay high, unless one or both of two things happen:
The Fed lowers the Fed Funds rates drastically and rapidly
The Treasury steps in to buy certain maturities to keep yields low
Or, of course, a major credit event occurs that threatens the Treasury market (that Financial Crisis that we will never see in our lifetimes happens yet again), and the Fed and Treasury team up to flood the market with liquidity by monetizing the debt.
Rates in this case would likely plummet.
So it seems that:
The Fed is playing chicken with the economy.
The Treasury is playing chicken with the markets.
And the markets are playing chicken with both.
But in the end, the system is only set up for a one-way street out of this mess.
QE Infinity.
So maybe, just maybe, Wall Street isn't so crazy after all.
That’s it. I hope you feel a little bit smarter knowing about The Treasury Re-Funding and it helps you in your own investing knowledge and process.
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Talk soon,
James✌️