On November 8, 2022, I posted the piece\u00a0 called “Are we Still in Kansas?”\u00a0 As almost a year has gone by, I thought a look-back might be worthwhile.<\/p>\n
In that piece, I wrote, among other things:<\/p>\n
” … some math to consider.\u00a0 Under the recent QE program, the Fed was buying about $1T in US Treasury securities per year, and about $500B mortgage-backed securities.\u00a0 The 2022 fiscal deficit was $1.4T.\u00a0From 2020-2022 the fiscal deficits have totaled about $7.5T and the Fed has net funded over $4T of that, monetizing $4T of debt.\u00a0 So, the Fed has been the marginal buyer of the majority of the increase in US Treasury supply since before the pandemic. To be sure, we have seen a run-up in Treasury yields in 2022 as QE stopped and QT began, all while the deficit ran to $1.4T in 2022.\u00a0 But going forward, the Fed process is reversing (remember, year-to-date the rundown of the Treasury General Account has completely offset QT so far).\u00a0 While the fiscal deficit for 2023 is forecast to lower to “only” $900B (optimistic), the Fed is SELLING over $1T per year of US Treasury securities under the Quantitative Tightening regime instead of buying that $900B as it would have under QE.<\/em><\/p>\n So, there is a marginal increase in supply of US Treasuries in fiscal 2023 of over $2T<\/strong>\u00a0($900B deficit + > $1T QT) versus 2022, which has to be absorbed somehow.\u00a0 We have lost the largest buyer of US Treasury securities for the last several years in the form of the Fed.\u00a0 We have also lost the second largest buyer of US Treasuries in the form of foreign central banks.\u00a0 \u00a0Looking further out, by 2032 the CBO forecast is for an AVERAGE of $1.6T in federal deficits per year, adding another $14-16T or so of debt to be absorbed.\u00a0\u00a0So, who is going to buy that increased supply of US Treasuries next year and over the next decade, and at what interest rate, if not the Fed?\u00a0 (A lot more to discuss here but that’s for another day).<\/em>”<\/p>\n Fast forward to October 2023, the $900B deficit forecast from that time period was indeed optimistic, having nearly doubled to $1.7T.\u00a0 That means the market has to absorb that $1.7T PLUS the $1T of QT from the Fed.\u00a0 A total of $2.7T of Treasuries represents 10% of GDP roughly.\u00a0 The question remains: who is going to buy those Treasuries, and what is the implication for the level of interest rates needed to clear them?<\/p>\n As I write, the US 10-Year treasury flirted with 5% despite two regional wars, meaning the flight to quality isn’t behaving consistently with historical behavior.\u00a0 We may be seeing a bid today (10\/23\/23) as hedge fund manager Bill Ackman unwinds his funds’ bearish bets on USTs.\u00a0 \u00a0There is more chatter that the Fed is done raising rates.\u00a0 But, that doesn’t change the overall fact that interest rates on USTs have zoomed past 15-year highs over the last 4-6 weeks!<\/p>\n As it relates to who is going to buy them, we know (or greatly suspect) its not the Fed, we know its not the Bank of Japan, we know its not the PBOC, and we know that banks are less interested in UST due to current portfolio losses and due to proposed increased capital requirements to hold treasuries.\u00a0 These are the four largest buyers of UST going back a while.\u00a0 Is Bill Ackman going to buy UST or just unwind his shorts!<\/p>\n Does the loss of historical largest buyers of UST help explain the recent run-up in UST yields despite two regional wars?\u00a0 It does to me.\u00a0 What does it mean for the future direction of interest rates?\u00a0 Are there other potential flashpoints in the world that could cause the typical flight to quality?\u00a0 Sure: oil-rich Azerbaijan’s recent conflict with Armenia-leaning Nagorno-Karabach could expand to Armenia itself.\u00a0 Serbia and Kosovo are potentially at it again.\u00a0 Not to mention Taiwan.\u00a0 However, those seem more like “trades” in UST to me than true investment, though if that happens this trade could run some amount of time, to be sure – there is still a lot of money swimming around as discussed below.\u00a0 To me, true investment will be driven more by the disparity between the $2.7T (or more) annual supply of UST and the world economy’s demand for that amount.<\/p>\n Consider the following:<\/p>\n What this all means to me is that the fundamental forces affecting UST yields are going to keep upward pressure on yields so that we can line up enough buyers to invest in UST instead of investing in something else.\u00a0 Of course, the Fed could decide to re-start their historical asset-buying to protect the federal budget deficit, bringing back the largest buyer of UST over the last 5 years or so in the process.\u00a0 As I wrote in last year’s post: Will we return to Kansas at some point?\u00a0 Maybe, perhaps even probably.\u00a0 At some point, it would not be surprising that the Fed will have to lower interest rates and resort to again buying assets.”<\/em><\/p>\n If (or when) the Fed does this, it will increase the money supply, which should be expected to have the impact on prices that we’ve seen over the last few years, i.e. inflation should be expected to re-appear instead of prices continuing moderate.\u00a0 To date, the Fed has reduced its balance sheet liabilities to about $7.9T from a peak of about $8.9T.\u00a0 Money supply as expressed by M2 came down from $21.9T in April 2023 to about $20.8T in September 2023.<\/p>\n On top of those events helping inflation to subside, the Treasury General Account has take another $800B out of the economy by increasing its balance from $40B in May (pre-debt deal) to $840B in October 2023.\u00a0 That represents eight months of Fed QT in only 4 months.\u00a0 So, these figures help explain why core inflation has come down.<\/p>\n But, interest expense in the Federal budget is beginning to explode and neither party is demonstrating the onions to do what is needed to restrain spending.\u00a0 Taxes can only go up so much before adversely affecting GDP.\u00a0 Right now, Fed liabilities to GDP ratio is still 29%, down from a peak of 35-36%, when historically it has been below 10% and was never above 16% prior to 2008. So, there is still a lot of money in the system. That is why the “last mile” of the fight on inflation is difficult this time.\u00a0 And, this is even before the Fed may revert back to QE, or even before our politicians get religion and address the deficit (which will hurt GDP in the process, keeping ratios elevated, etc.).<\/p>\n We’re in a tough spot.\u00a0 What to do?\u00a0 As I wrote in November 2022: “… 1) increase cash to the extent you can, 2) if you don\u2019t have a working capital line of credit, try to get one, 3) use a higher interest rate for capital planning purposes than you have been, and 4) modify the design of your project to fit within the new cost reality<\/em>.”<\/p>\n These remain important management considerations as conditions have worsened than outlined when I wrote that.\u00a0 We’ll get through this.\u00a0 Focus on why you started your school(s) in the first place, and know that your efforts are worth it and will positively change the trajectory of your students’ lives for years to come.\u00a0 And as always, let me know if you need to talk something through.<\/p>\n","protected":false},"excerpt":{"rendered":" On November 8, 2022, I posted the piece\u00a0 called “Are we Still in Kansas?”\u00a0 As almost a year has gone by, I thought a look-back might be worthwhile. In that piece, I wrote, among other things: ” … some math to consider.\u00a0 Under the recent QE program, the Fed was buying about $1T in US… read more<\/a><\/p>\n","protected":false},"author":3,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[1],"tags":[],"class_list":["post-504","post","type-post","status-publish","format-standard","hentry","category-uncategorized"],"_links":{"self":[{"href":"https:\/\/www.buckfinancial.net\/blog\/wp-json\/wp\/v2\/posts\/504","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.buckfinancial.net\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.buckfinancial.net\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.buckfinancial.net\/blog\/wp-json\/wp\/v2\/users\/3"}],"replies":[{"embeddable":true,"href":"https:\/\/www.buckfinancial.net\/blog\/wp-json\/wp\/v2\/comments?post=504"}],"version-history":[{"count":3,"href":"https:\/\/www.buckfinancial.net\/blog\/wp-json\/wp\/v2\/posts\/504\/revisions"}],"predecessor-version":[{"id":507,"href":"https:\/\/www.buckfinancial.net\/blog\/wp-json\/wp\/v2\/posts\/504\/revisions\/507"}],"wp:attachment":[{"href":"https:\/\/www.buckfinancial.net\/blog\/wp-json\/wp\/v2\/media?parent=504"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.buckfinancial.net\/blog\/wp-json\/wp\/v2\/categories?post=504"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.buckfinancial.net\/blog\/wp-json\/wp\/v2\/tags?post=504"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}\n