If low inflation, a shaky economy and tariff jitters were not sufficient to push the Federal Reserve to lower interest rates, there is also the simple reason of the swelling national debt.
The current debt deal struck between the White House and Congress virtually guarantees trillion-dollar deficits well into the future as well as continued acceleration of the government’s collective IOU, which is currently at $22.3 trillion.
Attempting to fund all that red ink will be tricky. Investors will have to be prepared to sop up all that paper, and might want a little additional yield for doing this.
With all that in mind, the Fed could not have any choice but to lower prices, unless it needs to return to buying Treasurys itself.
The source of debt coming to market will lead to “acute funding stresses,” Credit Suisse managing director Zoltan Pozsar stated in a note. He called the situation a “‘fiscal dominance’ of money markets” and warned of the consequences of an inverted yield curve, in which the fed funds rate stays nicely above the benchmark 10-year Treasury note yield.
“Absent a technical bazooka, stresses will leave one option left: more rate cuts,” he explained. Reductions in the benchmark overnight funds rate will have to be “aggressive enough to re-steepen the Treasury curve such that dealer inventories can clear and inventories don’t drive funding market stresses.”
“The curve remains deeply inverted relative to actual funding costs that matter; dealer inventories are at a record; and banks that fund dealer inventories are at their intraday liquidity limits,” he added. “Supply won’t be well received given the inversion.”
Markets anticipate the Fed to cut rates after July’s 25 basis point decrease, the first time that was done in almost 11 years. Popular reasons for the cut are concerns the global economic downturn will sabotage the U.S. , the low inflation which policymakers fear has held back living standards, and the continuing tariff war with China.
What rarely gets mentioned is exactly how much pressure the government debt situation transports, especially with the Fed deciding to depart the bond market.
The taxpayers’ tab
Credit Suisse estimates that the Treasury Department will issue $800 billion in new debt before the end of the year and boost its cash balance by $200 billion, or more than double the current $167 billion.
Over at the Fed, the central bank just finished a program where it was decreasing the bonds it had been holding onto its balance sheet by enabling a few profits to roll off every month. Pozsar called the conclusion of the so-called qualitative tightening “a nice gesture, but not a solution.”
The most viable solution to relieve market pressures, he said, is a rate cut.
“We recognize that the Fed doesn’t bend to the circumstances of dealers and carry traders, but we’d also note that we never had this much Treasury supply during a curve inversion on top of record inventories with leverage constraints!” Pozsar wrote.
Taxpayers, of course, are on the hook to people purchasing the government’s debt.
Servicing costs for the dent in the current financial year are just shy of half a trillion dollars — $497.2 billion during July — and sure to pass 2018’s record $523 billion. Over the last decade’s debt explosion, taxpayers have shelled out $4.4 trillion in funding costs.
President Donald Trump has repeatedly pushed the Fed for more rate reductions and an end to quantitative tightening, mentioning the competitive disadvantage the U.S. has with other global markets where central banks have loosened.
If the Fed not send, Pozsar stated there could be troublesome market benefits. He said the funds rate may wind up printing out the 2% to two. 25% range in which Fed targets the benchmark, and there probably would be stresses from the global overnight markets which could be tantamount to a different hike.