Updated: Oct 19, 2020
March 2020: Foreign investors offload $300 billion of US govt. bonds equating to a mere 1.3% of the outstanding bonds, only to encounter very low buying interest including no buyers at any price at one point. The bid/ask spreads double over the 2008 crises.
At $22 trillion the US govt. bonds account for ~30% of the global sovereign debt. This debt is widely held globally & underpins planets’ financial system from credit spreads to ratings.
US treasury bonds are naturally assumed to be the safest, with the highest demand & most liquid assets if not on par with cash. So while trading condition in US treasuries were less than ideal for some time, what exactly happened in March and what does it indicate?
Further, what is revealing is how the fed reacted to it.
So what happened?
Initially, fingers were pointed at speed/electronic trading & hedge funds, which proved to be insignificant contributors.
It turned out US commercial banks and funds were unable to buy as they already had existing large positions in US treasuries.
The fundamental reason for lack of demand for a mere $300 billion of apparently worlds safest bonds in a $40 trillion US debt market with well-capitalized banks remains unclear to us.
Fed response was a combination of the following 3 key steps which raises further curiosity:
Purchase >$2trillion of US bonds by increasing its liabilities (currency printing) & holding the purchased bonds as assets on its balance sheet.
Ease capital requirements on commercial banks for holding US govt. bonds.
Encourage foreign banks to accept swaps from fed as opposed to seeking cash from the fed / market.
So what all of this is essentially alluding to?
Specifically what forward indicators we may be missing as we are dealing with deeper credit but not equity side challenges…?
US bond market at about $40 trillion is larger than the equity markets ($ 30-35 trillion). Do the events indicate that the firepower of the fed, underpinned by its “unlimited” ability to print currency may be finally reaching its limits? Is this due to the quantum of total currency printed at $7 trillion relative to the tax base of the country, the large size of credit markets & feds own equity base…?
Further, is the federal government's ability to support the fed in a meaningful way getting restrained by decreasing tax revenue due to pandemic, limited liquidity/demand from US bonds, on top of the existing $ 1 trillion deficit?
In the near term equity of fed & especially combined equity of the fed & commercial banks, adjusted for private assets purchased but not off-loadable, remains unclear & may be a key driver of its ability to support dollar & markets.
US treasuries bedrock or tectonic plates? You decide.
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