Strange Tides in Global Macro
For the last few months, things have felt a little weird out there. Is there a recession coming? Are we in a recession already, but it’s just not clear? What is the Fed going to do?
We find ourselves on strange tides in global macro, perhaps best summarized by this recent tweet taking inventory of the odd coincidence of economic trends:
These trends are bizarre, but that’s because the underlying macroeconomic conditions are bizarre.
When things break in the financial system, it doesn’t happen overnight. We remember late 2008 as a crisis that materialized overnight, just like we remember the 2020 Covid stimulus as an emergency intervention. But we easily forget that in both cases, things were weird in the financial system ~6 months earlier. In early 2008, Bear Stearns went under; in 2019, repo market utilization spiked and the entire financial system began to wobble.
In macro analyst Luke Gromen’s opinion, “the beatings in [sovereign debt] will continue… until we get a repo rate September 2019 spike, except in Western sovereign bond markets. Then, everyone’s going to say, ‘how did nobody know the Fed had broken something?’ And I’m telling you, they’ve already broken something.”
That’s the key piece. The weirdness out there is because the Fed has hiked rates from ~0% to ~5.5% in record time. That takes the oxygen out of the room. It just takes some time for the inevitable to unfold.
The rest of this article will take a look at the factors at play that point towards the simple thesis that the Fed’s rate hikes have already broken something, it’s just slowly materializing.
US National Debt setting new records
You probably heard the recent headline: the US National Debt officially passed $33T. That means that since the debt-ceiling debate was resolved in May, the National Debt has grown at a blistering 18.5% annualized rate. To put that in perspective, if that pace continues for a full year, we will have added $6T to the National Debt.
And indeed, in the one week since the $33T mark was breached, we have now already reached $33.1T. Including nights and weekends, we are racking up federal debt at an incredible rate of $10M every single minute.
US Treasury considers Japanification
Tucked into a recent Bloomberg discussion with US Treasury Department assistant secretary, Josh Frost, there was something new. A statement framed as business-as-usual that is anything but: “The Treasury is expected in 2024 to start regularly purchasing its bonds” with the dual objective “to bolster liquidity in some pockets of the market and to smooth the volatility of bill issuance as it manages its cash balance.”
The subtext here is that there are not enough buyers to absorb the amount of US Federal debt issuance that will be coming on to the market. This means that the US Treasury is prepared to step in as a “buyer of last resort” in the Treasury bond market. This is the playbook that Japan has been running for the last few decades, stepping in with a blank check to effectively nationalize the assets that nobody in the marketplace wants to buy.
To date, the US Government has softened the impact of the bond sell-off by backstopping the private sector with the BTFP, which is effectively a blank check program to cover the considerable unrealized losses that have accrued for financial institutions holding US Treasuries, as this chart from Joe Consorti highlights.
But now, the US Government is preparing to take on the problem more directly.
In terms of major milestones in the ongoing erosion of the US fiscal position, this stands out as a major threshold. But of course, it is being framed as just a small program that will not be used during times of crisis.
Again, reading between the lines, this is more likely a sign that the US Treasury realizes that it needs to quietly position itself to become a “buyer of last resort” in order to prop up the Treasury bond market as interest expense on the National Debt continues to soar, driving greater deficits and the need for more debt issuance.
From the circumstances of the US National Debt and the behavior of the Treasury, it’s evident that the sovereign debt situation is headed for more pain. The only necessary ingredient is more time, and here’s why…
Reverse Repurchase Agreement (RRP) piggy bank
In 2021 and 2022, US Fed overnight Reverse Repo went up to $2.5T. This meant Banks found the risk-free return offered by depositing assets overnight at the Fed more attractive than investing. This sucked the liquidity out of the market.
But now, that dynamic has reversed – banks can find attractive rates by investing deposits into Treasury bonds and other instruments. And that’s what they’re doing.
$1.1T of deposits have exited the Fed’s Reverse Repo facility in 2023. The effect of this exodus is actually to inject that liquidity back into the system. All of this money becomes buying pressure for bonds and other instruments, as it comes out of the Fed Reverse Repo facility and needs to be placed into assets.
In effect, the $2.5T in Reverse Repo deposits are acting like a piggy bank being drawn down. This liquidity has injected capital to mitigate the bond market selloff, but perhaps more importantly, has provided the necessary buyers for the US Treasury to issue new debt.
But like all piggy banks being depleted, this doesn’t last forever. At the current rate, the Reverse Repo deposits will be exhausted in nine months. At that point, it will become considerably harder for the US Treasury to fund multi-trillion-dollar deficit spending. (And that is why the Treasury is preparing to start purchasing its own debt, using its unique power to issue blank checks on behalf of the American public.)
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