In a "free market", when the majority of buyers cease buying and inventory continues to increase, prices typically fall (and in the case of bonds, yields rise). However, this is not the case for the worlds largest and most liquid asset class, US Treasury debt. Since the Fed completed the taper and ceased outright QE in October of 2014, neither the Fed nor foreigners have purchased a single net new US Treasury while issuance continued unabated, rising by an additional $1.6 trillion (although further issuance since Trump was inaugurated has ceased due to the absence of a debt ceiling resolution...(more on this later).
The fact that up to 80% of marketable US Treasury buyers would cease buying with no negative impact on rates deserves a little deeper dive, particularly as the Fed now intends to begin allowing up to $30 billion/month in Treasury's (and $20 billion/month in MBS) to roll off it's balance sheet (anti-QE) until it's balance sheet is roughly halved.
The first chart below shows monthly 10yr Treasury rates versus the periods of Federal Reserve purchasing (QE, Twist, and Taper). Interestingly, during periods of QE, rates generally rose and only fell once QE phase-outs were announced or during tapering. Also interesting, the chart highlights when at the end of QE2 China ceased buying and began selling...and rates fell significantly further. Likewise, when QE3 ended and nearly all sources of buying vanished aside from "domestic buyers", rates fell again confounding 100% of polled economists who unanimously expected rates would rise.
This should be raising all kinds of questions and alarm bells...but funny enough, all I hear are crickets. To build some context for the accusation I'm about to level, I'm going to take a quick side trip into the Japanese bond market.
Those familiar with Japan's JGB (Japanese Government Bond) market are fully aware that it is in fact not a market in the least. The chart below (from Bloomberg) shows Japanese government debt (in excess of $10 trillion) to Japanese GDP (just in excess of $4 trillion).
And a look at the annual issuance of new debt since 2007 (below)...broken out by type of bonds. Those in blue and magenta (construction and deficit bonds) to fund new deficit spending but the vast majority or 2/3rds, in black, are "refunding bonds" used by the Japanese central bank (BoJ) to purchase and replace maturing bonds. Again, chart from Bloomberg and article Quick Guide to Japan's Government Debt. The primary and perhaps only buyer for Japan's $10+ trillion in government debt (10yr JGB presently yielding 0.07%) is the Japanese central bank buying these maturing bonds via "money" it creates out of thin air rather than via tax revenue. Of course, the Central banks aims are politically driven economics and it need not concern itself with trivialities of profit or loss.
Of course, the reason this is beyond ludicrous and a bridge to nowhere is the chart below.
- The purple line is the Japanese child bearing population from 1950 through 2015 versus the columns representing the number of births in Japan (per 5yr periods).
- The Japanese childbearing population peaked about 1970 and has presently declined by 10 million (a whopping 22% decline and births have decided by 50%...perhaps good to remember here that a depression results from a 10% decline in GDP).
- From 2015 through 2050, the chart shows the UN medium and low childbearing population estimates.
- In total, by 2050, the childbearing population will be somewhere between 55% and 65% smaller than the 1970 peak...and births are far likelier to hit the UN low estimate around 2.7 million per 5yrs...or nearly a 75% decline in births from the twin peaks of 1955 and 1970.
The idea that Japan can incessantly create and consume ever greater debt (only to service its ever greater debt load) against this magnitude of population collapse (and resultant collapsing consumption) to spur economic "growth" is somehow not seen as completely ludicrous. There is little doubt Japan can find means to produce more via innovations of all sorts but a collapsing pool of potential consumers for that output (domestically and globally) makes greater production or more efficient production a moot topic. Japan will not have anywhere near enough buyers for its existing stock of homes, used cars, and general economic output as its population is plunging. I show all this to explain why Japan will never willingly return to a free market allowing prices to be set based on supply and demand...and that Japan's foundation is now built upon a set of "colossal untruths" so daunting that none (of import) are willing to even note that "the emperor" is standing buck naked.
- 1776-->2007: What should be clear is that the primary buyer (certainly since 1970 through 2007) was the Intragovernmental surplus taking down nearly half of all US debt while simultaneously reducing the need for greater debt issuance. This reduced the marketable debt issuance by half that Foreigners and the domestic public essentially split. The Fed only held a relatively small portion of short term debt.
- 2008-->2014: The Treasury issued nearly as much debt from '08 through '14 as it did over the previous 231 years, but the sources of buying radically changed. It was foreigners who purchased nearly half of all US Treasury's, the Fed and domestic public nearly a quarter each as IG buying plummeted due to declining revenues from SS.
- 2015-->2017: Since QE ended in October of 2014, the Fed has ceased outright buying and foreigners have been net sellers, leaving the buying to the domestic public with a small and declining assist from the IG fund.
And below, what this looks like on a % basis.
Some questions that might be worth asking as the US Federal government has issued about $20 trillion in Treasury debt and total global debt is somewhere around $220 trillion (the majority of the interest rates on this global debt are driven by the US Treasury rates).
- Since the Fed and Foreigners (as a collective) aren't buying a single cent of net new Treasury debt since QE ended...who is "other"?
- With 75% of historical buyers now only net selling, why haven't 10yr rates risen (rates were over 3% when the tapering began, over 2.5% when the taper ended, and sitting at 2.28% as I write this)?
- Why did Foreigners cease buying and what is the linkage of the Foreign abandonment of accumulating Treasury's to the end of QE?
- A sub question, from 2000 to July 2011, China recycled 50% of its dollar surplus into Treasury debt. However, China's Treasury holdings peaked in July 2011 (coincident with the US debt ceiling debate) and have net declined by over $200 billion since (a 15% decrease). This net selling in Treasury debt has happened while China's dollar trade surplus with America has reached record quantities......why was there no negative impact on rates and were have those record dollar surplus' been going?
- Since the domestic public is left to shoulder nearly all the Treasury buying, why aren't other markets (equities, real estate, corporate bonds) suffering absent the huge quantities of dollars supposedly flowing into still near record low yielding Treasury's (and away from these other asset classes also at record highs)?
- FYI - The collective Fed / Foreigners averaged nearly $70 billion in monthly Treasury purchases from '08-->14...and are have net sold an average of a billion plus monthly since QE ended.
- The US Domestic public has purchased at a record pace since QE ended...nearly $50 billion monthly and double the pace from '08-->14. This is presently more than 10x's it's long term average.
- Later this year, the Fed intends it will begin "winding down its balance sheet" and progressively selling larger quantities of Treasury's (and MBS) while continuing to raise rates. Simultaneously, the debt ceiling (which has meant no net new Treasury debt has been issued since Trump became President) must be raised. The Treasury will subsequently flood the absence of Treasury buyers with something in the order of a half trillion + "catch up" issuance to pay back all the governmental funds it is presently raiding to fund federal spending.