Friday, October 2, 2015

Today's Stimulus And Who Will Pay Tomorrow's Bills?

The US is currently engaged in a stimulus program which I hear no one speak of and likewise I see little discussion of who it is that will be buying all those Treasuries once Congress gets around to raising the debt ceiling, likely in excess of $20 trillion.
  • $400+ billion stimulus in 2015 no one is talking about.
  • Zero (net) Treasury issuance since May will be offset by $400-$500 billion issuance plus ongoing spending come December and the hike in the debt ceiling.
  • Half of the natural sources of Treasury purchasing have ceased, the remainder slowing dramatically...3 scenarios who will buy this upcoming Treasury issuance and at what rates?


The US Treasury hasn't issued a bond, bill, or note (net) since May of this year...while the US has been busy spending above and beyond its tax revenue. This is because Congress has not raised the debt ceiling limit. So, Mr. Lew and his crew have been busy ransacking government pensions and the like, taking the money to maintain US government spending and hanging IOU's in their place. This is all with the sure knowledge Congress will eventually raise the debt ceiling...but not until political gain has been extracted from the "crisis".
Of interest, by the time the revised CR expires in December...the US will have spent about $400-$500 billion'ish without issuing a single net new Treasury. This means since May of 2015, $400-$500 billion has been spent without any correspondent dollars removed from the US or global economy for this spending. One might have thought the economy and/or markets would be a bit flush with a half trillion spent absent the half trillion removed to purchase these. Instead, the S&P has fallen about 5% from its peak during this time. Strange indeed.


The pool of potential Treasury buyers has been cut in half and maybe worse. Of the 4 potential sources, 2 have entirely ceased purchasing and the remaining 2 are riddled with curious questions.
The 4 sources of purchasing:

1- The Intra-governmental trust funds have ceased accruing surplus with which to buy Treasuries.
2- The Fed has ceased additional QE and is "only" maintaining its current $2.4 T balance sheet of longer duration Treasuries.
3- Foreigners have generally split into two groups...
  • The vast majority of foreigners, particularly the BRICS, have entirely ceased recycling their large excess dollar reserves into Treasuries and have become net sellers. Gold or other hard assets appears to be the location these dollars are being recycled.
  • This leaves a strange assortment of small, finance based foreign nations, a group I named the "BLICS" (Belgium, Luxembourg, Ireland, Cayman Islands, Switzerland) to maintain the foreign bid for rollover and new issuance.
4- Domestic public, primarily institutional money of insurers, pensions, banks, etc. many with plan payouts based on 7.5% returns. With today's 10yr yield a not so juicy 2% and the 2yr a paltry 0.56%, the greater % allocated to Treasuries, the greater the returns on the remainder of their portfolio must be to make up the difference. Why these institutions would step in as a willing buyer at these rates, essentially digging themselves a hole, is a good question. Perhaps they will refuse until rates are closer to their long term average, 7.5% at which point holders can live with the return but this would eventually drive 25-50% of government tax revenue to interest payments.


The 1st chart below highlights the importance of the Intra-Governmental (SS trust fund, etc.) purchasing of US debt up to 2008. However, the surplus funds have ceased and only 10% of all debt since '08 has been soaked up by the trust fund. The purchasing seems to have halted and could turn to outright selling. Regardless, the buyer of 45% of all US Treasury debt until '08 is no longer a "buyer".

Below we focus on the buyers who bought 90% of all debt since '08; Of this 90%, Foreigners (47%), the Fed (23%), US domestic public (30%). Of course, the Fed sold all shorter bills and notes along the way and focused all their purchasing on the 7yr to 30yr maturities while the domestic public is largely over-represented in the short end, using bills and notes as short term cash.

Below, the relative debt issuance over the two periods. But as noted earlier, the current period spending is actually closer to $3.8 trillion but the Treasuries have yet to issue the bonds for the monies already spent.

The next three charts show the changing nature of US Treasury purchasing since 2000.

The waning importance of the SS Intra-Gov trust fund,

And since June 2011, the Treasury market buy-in


Scenario 1 - US Domestic Public does the buying with an assist from slowing foreign purchasing. This wouldn't naturally be in domestic buyers self interest, as discussed above. Thus, my guess is the Fed declares NIRP sometime in early 2016 allowing those large institutional buyers currently enjoying ZIRP to buy bonds. This would allow these large buyers access to guaranteed returns and they may be "encouraged" to buy Treasuries yielding next to nothing along with continued share buybacks.

Scenario 2- BLICS and Japan take over and continue buying at current or even lower yields. Despite the BRICS abandonment of Treasury buying, the BLICS (with an assist from Japan and some portion of US domestic purchasing) step forward as the primary creditor for the US. This is the scenario we've seen over the past 4 years.
Chart below are the decelerating sources of buying. Strange those with excess dollar reserves to be recycled slowed and/or ceased recycling them into Treasuries. And for China, still running record trade surplus with the US the whole while, the change began in July '11...the last debt ceiling debacle. China had been recycling 50% of its excess dollars into Treasuries from '00 until June '11...since then, they have been a net seller on record surplus!?!

And below the sources that accelerated as bond yields collapsed. The same sources that have no excess dollar reserves to recycled. Or otherwise said, those sources who did not seem to have a profit motive guiding their buying.

Scenario 3 - The Fed backtracks on all pretense QE was a temporary or emergency program and restarts QE4EVER.

Btw- I anticipate a US and global economic slowdown simply due to demographics (discussed here). NIRP is multi-pronged tool allowing Congress to issue significantly larger deficits with "free money" and lowering federal interest expenditures...alongside encouraging corporate buybacks and refinancing of existing corporate debt, it discourages investors who would consider selling as they will be ensured losses in their savings accounts. This also ensures Treasuries are "un-investible" due to low yields thus crowding investors into stocks and real estate with record low mortgage rates?!? Yeah, I'm guessing NIRP is only a matter of time.