Governments gorged on historically low interest rates since 2009 and issued record amounts of debt to fund all sorts of silly spending programs from economic “stimulus” checks to QE. Debt securities are subject to the laws of supply and demand as is any commodity. We have too much paper outstanding – especially as it relates to the Treasury market – therefore Treasury prices will move lower as yields climb higher. Treasury and the Fed won’t be able to resist intervention rather than allowing the Treasury market to find natural price/yield equilibrium. Intervention means inflation will be here to stay for an extended period. Persistent inflation combined with high debt levels essentially guarantees low economic growth. Thus, “Stagflation” will be the word used to describe the economy of the 2020s.
We have heard rumblings of an illiquid Treasury market over the past few weeks. Of course the Treasury market will hit pockets of illiquidity. Treasury issued and the Federal Reserve purchased trillions of Dollars of Treasury securities to fund various fiscal spending programs in response to COVID, to say nothing of the Fed’s QE programs that have consistently run since 2009. There is an oversupply of Treasury securities. If the Federal Reserve had not stepped up to purchase those Treasuries over the past 13 years, those securities would have traded lower or perhaps not found a buyer at all.
Today, the Fed is a net seller of Treasuries (allowing balance sheet holdings to mature), therefore it only makes sense that Treasury prices move lower as yields move higher. There are not enough sovereign nor corporate buyers to fill the Fed’s shoes (the Fed purchased approximately $90 billion worth of Treasuries each month during its most recent QE run).
Government should allow the Treasury markets to clear. Illiquidity means prices want to move lower and yields higher, which makes sense given the over-supply of Treasuries. Several weeks ago Treasury Secretary Yellen said that Treasury may issue short-term Treasuries to purchase long-term Treasuries in order to add liquidity to the Treasury market. How will more QE solve the problem in the Treasury market, which is to say that there is far too much supply? Yellen’s brilliant plan will only add to the supply, further exacerbating the problem and ultimately forcing prices lower and yields higher.
The best thing Treasury and the Fed could do would be to stay out of the markets. Stay out of the credit markets, stay out of the equity markets. Allow the markets to find equilibrium, a process which will naturally have bumps in the road. However, they won’t be able to resist. They will try to manage this process as well. We may look like the U.K. in the near future where we are lifting rates higher while simultaneously running the next QE program. Guess what that means for inflation? It won’t see 2% anytime soon. We will be stuck in this Stagflationary environment of elevated prices, low growth and elevated debt for years to come.
The Public Debt (T-Bills, Treasury Notes and Bonds), grew by approximately $10 trillion as Government spending grew to an unprecedented and unwarranted level during COVID.
“Stagflation” will be the word to describe the U.S. Economy of the 2020’s.
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