Thursday, April 5, 2018

Near Record Treasury Issuance... But Who The Buyers Are May Surprise

I'd like to discuss the fourth quarter of 2008 vs. the first quarter of 2018.  The two quarters in which the US undertook the greatest increases in federal debt but supposedly represent entirely different outcomes (I'm excluding and smoothing out the Q3 2015 debt deluge after the Q1-Q2 debt ceiling debate).

The chart below shows total federal debt (red line) in perspective against real inflation adjusted GDP (blue line), the federal funds rate (shaded brown), and the 10yr Treasury yield (light blue shading).  It ain't a pretty picture.
During Q4 of 2008, the US undertook $675 billion in federal debt, dropped the FFR essentially to zero, and saw the 10 year Treasury yield drop to 2.3% while real GDP fell by over $200 billion.

During Q1 of 2018, the US similarly undertook $625 billion in federal debt.  But conversely in Q1 hiked the FFR to 1.7%, the 10 year yield rose to 2.8%, and Q1 real GDP likely rose around $125 billion.

Since the completion of Q4 '08, Federal debt has risen 97% (+$10.4 trillion) while real GDP has risen 19% (+$2.8 trillion).  Over this period, federal debt has consistently been rising 4x's faster than inflation adjusted economic activity...and as Q1 2018 highlighted, this trend isn't improving.

But looking at Q4 '08 and Q1 '18 Treasury holdings (side by side), something very strange has taken place.  In late 2008, as the financial and economic wheels were coming off and assets were abandoned for the comparative "safety" of Treasury's...the domestic public added a then record $324 billion in US debt to their holdings.  However, in early 2018, as the stock market and housing markets were reaching euphoric highs...somehow the same domestic sources added a mind blowing approx. $675 billion in Treasury debt to their asset hoard?!?

The chart below shows the quarterly net issuance on the left and the change in holdings by the four sources of buying on the right.  What you will notice is a seemingly unbelievable surge in US Treasury holdings by the "domestic public".  In Q4 '08, outstanding Treasury debt rose by $676 billion and although the Federal Reserve took none of that (QE didn't start until Q1 2009), the Intra-Governmental surplus (SS, etc.) ate up $77 billion (reducing marketable debt), foreigners (particularly China) scooped up $275 billion, and the domestic public (banks, insurers, pensions, etc.) was left to digest the remaining $324 billion.

Compare Q4 '08 to Q1 2018; Federal Reserve holdings declined by $30 billion (and the Fed's balance sheet is set to shrink by hundreds of billions annually through 2020) , the Intra-Governmental holdings fell by $16 billion as benefits paid out outpaced surplus revenue (likewise, this selling is set to accelerate as surplus turns to outright deficit), foreigners likely continued selling (foreign holdings, led by Chinese/Japanese selling, have declined by $65 billion from October through January) but the final Treasury TIC data won't be available until this I simply left foreign holdings unchanged.  This meant about three quarters of a trillion in net new Treasury debt was swallowed up by "domestic sources" in the first three months of 2018.  Further details on the situation are detailed here Who Will Buy Those Trillions of US Treasurys???
This amount of Treasury debt being ingested by "domestic" sources (particularly absent huge selloffs in other asset classes to raise the funds) is off the charts in its scale and simply very hard to believe.

Seems a deeper dive into who exactly those "domestic" sources are is in order.  Thanks to the Treasury Bulletin...we've got some idea.  As the chart below highlights since 2007, there are two sources doing all the heavy lifting.
Since QE ended in Q4 of 2014, Treasury debt has ballooned by $3 trillion, of which mutual funds and a grouping titled "other" have added over $2 trillion (taking in 70% of the net increase in Treasury debt).  For those wondering...according to the Treasury, "other" includes individuals, GSE's, brokers/dealers, bank personal trusts and estates, corporate and non-corporate business, and other investors.  The holdings of this group of "others" and mutual funds have mushroomed in size compared to those of insurers, banks, pension funds, or "private" investors.  It is an open and awkward question why the holdings of these two would surge while all other sources have eschewed US Treasury debt?

So, consider...
  • Issuance of new debt will continue to rapidly outpace growth in economic activity (or the taxation to pay for any of this)
  • Traditional sources of Treasury buying are turning into secular sources of selling (Fed, IG, foreigners, Petro-Yuan, etc.)
  • Assets remain near record highs indicating there is little to no selling with which to fund the domestic Treasury purchases
  • Yields on US debt have risen but remain near long term lows and are at best break evens with inflation...and far below acceptable long term returns for most fund managers
It is hard to believe all of this adds up to anything more than state level fraud.  That America's ability to fund it's massive deficits via the Treasury market and manage the interest paid on that rapidly growing pile of debt are no longer dependent on market participants...but likely being enforced by the very pointy end of American "diplomacy".

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