US Treasury move risks creating unintended consequences for markets and the economy
I think everyone has talked enough about the US Treasury move to double long-term debt buybacks this week, and its impact on broader markets. Bessent was even bold enough to suggest that they might do more and take further action if needed, considering that "yields do not reflect underlying fundamentals".
While the action by the US Treasury seems straightforward enough, there are potential risks associated to it. Thus, making it not so much a move that goes unpunished if they were to keep jerking markets around in this manner.
I mentioned yesterday already here how it can create a moral hazard of sorts and also how it could impact funding markets. So, let's continue to build on that just so we can be aware of what unintended consequences may crop up and bite at markets down the road.
As mentioned, the first is a moral hazard in the sense that a "Bessent put" acts as a backstop for the Treasury market. In that sense, it gives traders and investors a false sense of security in thinking that the US administration has got their back in going up against the market.
But as highlighted before, buybacks of $4 billion (or even if more than that) are but a drop in the bucket compared to the massive Treasury market of over $30 trillion.
Thus, traders and investors being open to take more leveraged and riskier positions could open a can of worms - especially if thinking that the government will always be their "buyer of last resort". If leveraged trades get out of hand, things will really get ugly when shit hits the fan and many traders are caught with their pants down amid over-leveraged positions.
The next point is an unintended overlap with Fed monetary policy. Typically, yield control falls in the domain of central banks. The US Treasury is meant to help to address the fiscal side of things instead, and not so much focusing on yield levels. Yet, here we are.
In this sense, it definitely complicates and blurs the lines of who is handling what when it comes to US policy setting. And in the bigger picture, it's a major red flag on both central bank independence as well as government debt handling. Then again, it's perhaps a good thing that markets have come to associate everything to one man now in the US. One orange man.
But all in all, it's again another big blow for the US dollar amid credibility issues and incoherent policy setting.
And then there's the point on how this all feeds through to other parts of the financial system, with buybacks potentially threatening funding markets.
In performing the buybacks, the government is essentially trading interest rate risk for liquidity risk in a sense. That sees the debt burden shift towards the shorter duration with the Treasury needing to fund buybacks via T-bills.
That forces dealers to absorb bigger amounts of T-bill issuances and that risks draining excess cash in money markets. Essentially, dealers i.e. banks are forced to hold more T-bills and have reduced amounts of cash to lend out to other insitutions for overnight funding.
All it takes is one timing mismatch and/or a temporary cash shortage and that will be enough to blow up the "plumbing" of the funding and repo markets - like it did in 2019.
And lastly, there's also the issue of fueling inflation pressures and distorting the reality in markets even more.
By "artificially" suppressing bond yields and its own borrowing costs, that just continues to pump more cash into the economy and stimulate demand conditions further.
Adding to that, there's that distortion where yields are not enough to pay back cover for inflation pressures. In turn, that will just lead to more spending from consumers and businesses to try and make back for the fact that holding cash then becomes a losing game essentially. So, that will also drive prices up if the narrative plays out for a bit longer.
To sum up, it is not to say that the US Treasury move is without any risks on the front of it all. There are potential risks and unintended consequences, just ones that may not be obvious and evident to markets just yet.
This article was written by Justin Low at investinglive.com.提供 MainLink：Investinglive RSS Breaking News Feed
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