In 2018 it was clear that Trump's excessive deficits would lead to debt refinancing risks that were similar to those of the Italian Tesoro following the 2011 peripheral crisis. This die was already cast before the Covid19 pandemic as the US private sector indebtedness was reaching saturation point and, just like in Japan, the government would have to support economic growth with fiscal policy. This is the "private to public debt growth switch" that I have discussed in previous posts.
The Covid pandemic has merely brought forward the day of reckoning that was already on the cards, simply because the private sector had no buffers and reserves for bad times, so the government had to step up to the plate.
The investor ramifications from this upcoming long dated debt issuance are huge. If the private sector has to finance this forthcoming tsunami of coupon issuance, you can bet that real yields will have to rise to attract those private sector savings away from private sector assets. This is exactly what 2018 was all about - real yields rose and stocks and corporate bonds got clobbered until the FED reversed its tapering exercise and started buying USTs in size.
My thoughts remain the same - see previous posts - the genie is out of the bottle and the Fed will of course come to the water and have to buy an ever larger amount of USTs to keep net supply and thus real yields low. This will be to try and keep financial assets afloat, which will of course allow bubbles to continue. The same will naturally occur in the Eurozone, UK and Japan. But take note from the previous charts, the increase in debt is NOT linear - the power of cumulation is at work.
Given the supply next year, it is fair to say that Central Bank QE had better NOT be temporary in nature, otherwise risk assets could move in a similar fashion to 4Q 2018 (when there was the terrible combination of large debt issuance, Fed unwinding its balance sheet and rising real yields). My guess is the FED and other Central Banks will continue to buy substantial amounts of debt, raising the question of what Temporary actually means.........and thus the title of the post.
Milton Friedman’s quip the “nothing is so permanent as a temporary government program” is particularly relevant when we think about the outlook for money printing. In simply terms, if there is not enough of money to go around, the central bank will print more. They don’t have much choice.
10-year yields extended the move above 1% today and the yield differential stocks enjoy over bonds extended its contraction to less than 50 basis points.
Government bonds yield just about everywhere rose today with the USA, Australia and New Zealand all sporting levels in the region of 10% and completing base formation characteristics.
With Treasury yields rising and the stock market firm, the Dollar’s oversold decline is due a bounce. There is scope for a rebound in the Dollar as part of a reversionary process until the Fed clearly announces measures to depress long-term yields. That would likely be the catalyst for another down-leg in what is an emerging medium-term bear.
If that theory proves prescient it could result is some profit taking in emerging markets and the unwinding of short-term overbought conditions before the medium-term bullish outlook is reasserted later.