Keyboards are being hammered into submission as pundits seek to convince readers that there is no chance of a Fed put while the Fed is tightening quantitatively. But the last few weeks in the UK have demonstrated the fallacy inherent in such a notion. The Bank of England bought just under £20 billion in what it deemed “Emergency Bond Purchases” after the astoundingly inept Liz Truss shat her pants in her debut budget.
And with the resurgence of the ‘bond vigilantes’ – a horribly misleading colloquialism suggesting an organized conspiracy to drive bond prices down and yields higher (when in fact it just means there are no takers of offers to buy sovereign bonds in a given market), the potential for a similar ruction in the US bond market is clear and present, as confirmed by this Reuters piece.
So why is there such little interest in buying Treasuries these days?
Envision the prospect of lending money to an individual addicted to opiates.
(I don’t think this requires any further elaboration, but nonetheless:) The risk is that the borrower is unable to repay, and therefore there is an immediate discount to face value, as reflected in the higher interest rate that the junkie must pay, itself a reflection of the elevated risk of default by the borrower. Never mind the risk of the borrower ascending to a higher place before maturity.
Logically speaking, there is zero rationale for the Fed buying bonds while it is jettisoning them from its balance sheet in an overt and public display of engaging the dark force of inflation in mortal combat. That would be the perfect visualization of the more apt analogy of “sucking and blowing”.
Though we have seen, through the Fed’s “overnight repo operations”, that the Fed not only sucks and blows as the vicissitudes of financial markets wax and wane at the Fed’s discount teller, but that it also is wont to blow twice as hard when circumstances warrant.
I am guilty of stating previously that we should expect to see a reversal in the Fed’s QT pace by November. In a sentiment inspired by baseball philosopher Yogi Berra, I have learned repeatedly it’s okay to predict the future; just don’t say when, and this is particularly poignant in the current situation.
I made that prediction in July this year as the Fed embarked on aggressive interest rate increases which continue as inflation stubbornly refuses to be ‘transient’ and instead looks poised to churn even higher. That being said, the prices of commodities are down, and this is usually the first indicator of inflation subsidence.
But last week it was revealed that the US Treasury is soliciting expressions of interest from its primary dealers as whether or not it should buy back its own bonds “to improve liquidity”.
Now, this is fascinating because it would essentially mean the Treasury department is going to step into the Fed’s role, thus shattering for eternity the tired old premise that the Fed is independent of government. This is ostensibly the tactic agreed upon behind closed doors in Washington so that the illusion of QT by the Fed can remain optically viable. But make no mistake: this is stimulus.
What is the Treasury department going to use to “buy” back its bonds?
More bonds? I mean, it’s the Treasury bond that underlies every dollar in circulation, so it stands to reason that the only way the Treasury can buy back its own bonds is by selling more bonds to raise the cash necessary to do so.
So while the “Fed put” is as yet unlikely, its return is inevitable. Just look at the record short interest in bond futures as covered by Reuters. Apparently, I’m not alone in expecting the Fed put to return sooner rather than later.
The deflationary impact of runaway interest rate hikes is probably far greater in Fed thinking than the risk of cost-of-living crises powered by runaway inflation. And at least, as the Fed (and now the Treasury department as well) sees it, at least their pals at the banks and hedge funds will benefit from the return of The Put.
It might be November, or it might be January, but the Fed put has only taken a breather for now, and with the Treasury suddenly stepping in, the check-kiting going on at the top of this utterly Orwellian “debt” constru
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