This morning US Treasury yields rose above yesterday’s high close. Now they are hovering right around it. Yesterday put the 10YR Treasury — fundamental in pricing mortgage interest — at its highest since 2007. This year’s meteoric rise, related in large part to a gaping US deficit, and the corresponding massive issuances of Treasuries following the government’s release from its the debt ceiling, now looks like this compared to prior years:
In response to what can plainly be seen, the Fed’s Bill Dudley writes today that the multi-decade bull market of US Treasuries is dead. Say, “Good-bye,” he says. It won’t be back for a loooong time.
Who knew that the subject of US Treasury bond yields could inspire such passion? When, in late June, I argued that they were likely to move considerably higher than the then-prevailing 3.75 percent, I attracted some vehement pushback….
I don’t know why he got pushback (other than blind denial of course). The trajectory for US bonds under scorching deficits, resulting in massive new Treasury issuances … in the Face of the Fed’s rejection of all bond buying … at a time when the debt ceiling was being lifted so the government had to make up for half a year of inability to raise debt … should have made it abundantly obvious that US Treasury interest rates would scream higher.
That was certainly the prediction here, and Dudley is holding to his guns on that prediction, too:
I’m sticking with my prediction. What’s more, I strongly suspect that the bond bull market that began in the early 1980s is over.
However, he adds,
I certainly didn’t anticipate that yields would immediately shoot up.
Well, I did because why wouldn’t they? Given the macro picture, how could they not? So, I made my case that bonds would, again, start to tear the face off of stocks but more importantly would start to damage banks again, as they had back in March due to rising interest (falling prices for banks that have to sell the bonds they hold from their reserves to avert/satisfy bank runs). On that basis, along with the fall in commercial real estate, I said we would be heading back to bank troubles because bank reserves would start devaluing shortly after the government disentangled itself from its self-imposed debt ceiling.
And, so here we are:
The US government’s fiscal health keeps deteriorating: Last month, the Congressional Budget Office raised its estimate of this year’s federal budget deficit to $1.7 trillion from $1.5 trillion, and no improvement is likely anytime soon given the political deadlock in Washington. The outlook will probably deteriorate further as higher interest rates drive up debt service costs….
The supply of government debt will be even greater than the deficit alone suggests. For one, the Treasury must borrow more to rebuild its cash balance at the Fed, after depleting it to get through the latest debt ceiling standoff. Also, debt must be issued to replace the Fed’s holdings, which are declining at an annual rate of $900 billion as part of the central bank’s quantitative tightening program – and will probably keep doing so for about two more years, even if the Fed reverses course on interest rates.
While those were ALL points that I made when laying out my prediction for rising bond rates/falling prices, the more critical point is playing out in this morning’s headlines with what just happened to banks:
S&P downgrades multiple U.S. banks citing ‘tough’ operating conditions
S&P Global on Monday cut credit ratings and revised its outlook for multiple U.S. banks, following a similar move by Moody’s, warning that funding risks and weaker profitability will likely test the sector’s credit strength….
S&P downgraded the ratings of Associated Banc-Corp and Valley National Bancorp on funding risks and a higher reliance on brokered deposits. It also downgraded UMB Financial Corp, Comerica Bank and Keycorp, citing large deposit outflows and prevailing higher interest rates.
A sharp rise in interest rates is weighing on many U.S. banks’ funding and liquidity, S&P said in a summarized note, adding that deposits held by Federal Deposit Insurance Corp-insured banks will continue to decline as long as the Federal Reserve is “quantitatively tightening.”
The rating agency also downgraded the outlook of S&T Bank and River City Bank to negative from stable on high commercial real estate exposure among other factors.
Here is how that works
As the Fed continues quantitative tightening, the amount of money held in bank reserves automatically lowers because the Fed is no longer refinancing US debt. Therefore, the government has to find other buyers. The money those buyers commit to government bond purchases gets transferred from the barks’ reserve accounts directly to the government’s Fed bank account to buy the bonds. Banks have to either sell bonds or use cash they hold in reserves to make those transfers.
At the same time, the government has to attract a lot more buyers to replace the Fed who is out of the Treasury scene for a good while to come. That typically means paying higher interest rates to expand the buyer pool unless a flood of buyers comes along for other reasons (such as flight of capital all of a sudden from other nations). Those rising rates further devalue the existing bonds banks hold in their reserve accounts at the Fed. With small nominal reserves and devalued bonds that must, at least, be marked down when sold, the banks wind up in the trouble we saw in March.
One other big factor comes into play against the banks as the Fed continues QT and continues holding its benchmark interest rates high: Ordinary bank customers can buy and hold US Treasury bonds and make respectable interest off of them all of a sudden. Also, corporate bond yields all rise because they have more risk that US Treasuries, so must price higher. That all presses banks to finally start competing because there IS something else for their depositors to place their money in. (No more TINA — “there is nothing else.”) So, bank costs also go up to pay out better interest on deposits. (Banks have had a lazy free ride for a long time!)
Cash reserves flushing away, bonds in reserve being devalued, and costs going up don’t align well for banks, which lose deposits in that flow, forcing them to cash out some depositors.
So, my prediction for the summer and latter part of the year has been a return of bank troubles made worse by the devaluation of commercial real estate.
There is plenty more in the “Economica” headlines and inflation headlines below about a recession now hitting as well.
Follow-through on the BRICS
You will notice one headline in the news below that says the BRICS are taking aim at the dollar, as if they are creating their long-wished-for new currency this week or taking steps in that direction. If you are able to read the article, given that it is on Seeking Alpha, a membership site, you will see they are not. (But I’ll tell you here what you would find.)
There is no mention in the article of any discussion on the agenda about a replacement currency for the dollar, just as I said there was not going to be (based on their stated agenda but also their practical inability to engage seriously in that kind of discussion when their own currencies are crumbling).
Again in the news this morning, we find China had to do yet another massive intervention to stem what is becoming an relentless collapse of the yuan this year, and we read a couple of headlines about how the nations around Russia (former Soviet satellites) are being damaged by the ruin of the ruble. None of that puts anyone in the mood at the BRICS summit to talk about a China-Russia-driven currency for all BRICS nations.
Instead, what we see is that the BRICS will be expanding its members and focusing on easing trade with each nation’s own currencies. This is exactly what I’ve said would happen since the start of Putin’s War and the Western sanctions related to that war. It would NOT create a multi-polar world as almost everyone was saying; it would create a BI-polar world.
The nations of the East that have been long against US hegemony and their forced entanglement with the dollar would band together to become a tighter trading bloc. That does not mandate by any means a universal currency between them any more than all members of the British commonwealth need to use the British pound.
At the same time, the nations of the West will be pressed by their joint desire to support Ukraine against the Putin’s imperial invasion, to band tighter together in order to survive their own sanctions. They will trade more with each other, as they have been doing.
That is what we see: Western alliances growing tighter by necessity if they are going to support Ukraine and those nation’s that have long been unfriendly with the West allying with the three main Eastern powerhouses — China, India and Russia. Those alliances are more fractured because some of the nation’s are longtime enemies (such as China and India) and because most of them still want and need very badly to trade with the US and Europe. Even OPEC nations, which sometimes struggle to work together on a solitary trade issue — oil & gas production — have a lot more in common culturally and historically than the larger BRICS and their partners.
So, the alliances are forming along that kind of bifurcation in the world, but the BRICS are held together by mud, while the West is held together by a couple thousand years of deeply interwoven Roman history and (at one time, at least) Christian culture. There is much more cultural, including religious, disparity in the East.
Anyway, as you read the lead article about the BRICS banding together to replace the dollar with a currency of their own (the popular narrative that keeps being pushed), you’ll find no evidence of such an actual effort, but much about expanding as a trade bloc. In the longer course of time (years), such a bloc, if it even succeeds in forming, may develop with enough cohesion to where they could attempt their own form of euro, but that would be much more difficult to actually pull off than in Europe due to the great disparity between the nations. Even this article notes the hesitance among two of the principal members to ally too closely with China, which they perceive as trying to make itself the next hegemon.
While China and Russia are pushing to expand the bloc, other members (Brazil and India) are hesitant. "Their primary motive for working with Beijing and Moscow is not necessarily that they agree with them," said Priyal Singh, senior researcher at Institute for Security Studies. "They are trying to pursue their own sense of strategic autonomy on the world stage."
BRICS nations account for more than a quarter of the global economy, but they differ vastly on political and security issues, including ties with the U.S.
The article talks about reducing “reliance” on the dollar but not a world about creating a new currency. Rather it is about using their own long-existing currencies more when trading with each other. Part of their big plan there is for their answer to the International Monetary Fund — their New Development Bank — will start lending to partner nations in their own currencies with a goal of hitting $8-10-billion this year.
That is a paltry sum compared to the IMF and is infinitesimally small as a threat to the US dollar. By contrast, the IMF anticipates loaning about $1-trillion in this fiscal year, about $160-billion of which is in US dollars. And that is just a US loan/gift to other nations, which can always end, and the IMF is just one tiny party of US support to other nations. There is also the World Bank that the US poor dollars through plus the United States’ own direct contributions.
I am sure more than a few nations being drawn toward the BRICS feel some reluctance to bite the dollar that feeds them. In the end, most of those BRICS members or would-be members will continue right on trading with the West in dollars and euros, even if they trade with each other in their own national currencies. So, the bite on the dollar will not be significant for a long time.
That doesn’t mean, of course, that the US can rest on its laurels regarding the dollar’s role or that endless use of monetary sanctions as a means of retaliation will not continue to erode support for the dollar.