EDITOR NOTE: Just how vulnerable is the US Treasury market? According to this author, it's sitting on a powder keg, and three things can cause it to implode. The author details each scenario in painstaking fashion. Yes, the article is a bit technical, but if you’re a precious metals investor, it’s important to understand what he’s saying. The effect on gold and silver will not be gradual or slow; rather, it’ll be sudden and swift, causing the prices of both metals to skyrocket in a way that may astonish even the most “religious” of gold bugs.
The debt treadmill that is the United States Treasury market is overheating. If you look closely, you can see the engine smoking now. Of course, the streets are littered with the bodies of traders that called the bond market top and lost. Nevertheless, here I'll try to make the case from a mathematical standpoint that the US Treasury market could implode at any time now, and that only one final trigger is needed.
The way I see it, there are three near-term catalysts that could trigger it:
- One more multi trillion dollar consumer bailout bill that would overwhelm currently available reserves in the US banking system of $2.82 trillion, triggering another repo market crisis as happened last September when short-term rates shot up to 10% overnight.
- A confirmed no deal Brexit that now looks to have a deadline of October 15, which could easily topple a sickly European banking system and cause a global domino effect.
- A contested US election that draws out.
If and when the Treasury market finally cracks, the chief beneficiaries in my view will be gold and silver which will skyrocket, while most other mainstream financial asset prices will implode. All risk is benchmarked to bond yields, so it all starts there. My raw numbers approach begins with Treasury Direct, together with a little help from the Securities Industry and Financial Markets Association (SIFMA), which helps organize and crunch the Treasury Direct numbers. All data in this article comes from those two sources, plus the Federal Reserve website.
$20 Trillion Outstanding, $4.7 Trillion Due in 6 Months
Setting the scene. As of the end of July, there are just over $20 trillion in marketable Treasuries outstanding. What many do not realize is that nearly a quarter of that debt pile, $4.7 trillion of it, is due in less than 6 months. Since the COVID-19 Era began in March (which I call CE and BCE for before), Treasury bill issuance of maturities of 6 months or less has totaled a colossal $9.62 trillion. This is in just 6 months. The table below compiled by SIFMA, lays it bare. Units are billions of US dollars.
BCE, it took a year to meet that same total, from February 2019 to February 2020. Prior to that, it took 15 months back to November 2017, and prior to that, 19 months. So the rate has been steadily increasing obviously for a long time, but a doubling like this we didn't even see in the immediate aftermath of the 2008 financial crisis.
For a sense of perspective here, the total amount of 10Y notes and 30Y bonds issued since the turn of the millennium has been only $6.45 trillion. So over 247 months, 10Y and 30Y issuance combined has only reached two thirds of short-term issuance over the last 6. This is how budget deficits are funded. On a hamster wheel.
Let's talk about percentages though. Here are two charts from Treasury Direct that show graphically how the breakdown of debt maturities has changed since the turn of the COVID-19 era. The first chart is from January, the second the most recent from August.
As you can see, the only debt metric that has changed significantly is short-term debt - Treasury bills, the left most bar on both charts. Outstanding figures have more than doubled from about $2.404 trillion to now over $5.079 trillion. Bills technically include 1Y maturities as well but total issuance of 1Y bills since March has been relatively miniscule, only $208 billion. For all intents and purposes, substantially all bill issuance now matures in 6 months or less. Here is the table from SIFMA:
From here we can see the percentage shift. In January BCE, T-Bills comprised 14.4% of total Treasuries outstanding. Now it's 25.4%.
Treasury Unable to Raise Net Cash from T-Bills Since June
It gets worse though. The fact is, the Treasury has been unable to raise any net cash from short-term T-Bills since June (units billions of dollars):
This is mainly because since March, the Treasury has had to issue record amounts of emergency paper called cash management bills, or CMBs, not to be confused with commercial mortgage backed securities. You can see these back in the first table. The Treasury has issued a whopping $3.6 trillion of this short-term emergency paper since March, substantially all of it with maturities of 154 days or less. You can find all outstanding CMBs here and their maturities. Including outstanding CMBs, total debt due just this month is $1.378 trillion. For October, it's $1.211 trillion so far, plus any CMBs with a maturity of less than 50 days plus 4-week Treasury bills yet to be issued.
These trillions will all have to be paid down with still more short-term debt, which will make it very difficult for the Treasury to raise any cash on net without substantially increasing T-Bill issuance going forward even more.
More Long-Term Debt Impossible
T-Bills are not where the real money is anyway for the Treasury. That has never been the case. According to SIFMA data, for the 15 years from January 2000 until November 2015, total net cash raised from short-term bills out to 1Y was only $535.8 billion, while the accumulated federal deficit for those years was $8.462 trillion. T-bills only covered 6% of that sum in that time. It can't cover much more than that because short-term debt constantly has to be recycled so quickly. Its purpose is short-term funding only, by the very nature of the maturities involved. It cannot sustain long-term spending increases.
In those first 190 months of this century for example, only 100 of them actually succeeded in raising net cash from T-bills. The other 90 were negative as gross retirement exceeded gross issuance. The real money is raised in longer-term notes and bonds. Note issuance, 2Y-10Y maturities, in that time raised a net $7.62 trillion, covering 90% of the total deficit for those years. 30Y bonds covered the rest.
So why not just issue more long-term notes and bonds then? Because it's impossible. Substantially more long-term debt is completely out of the question. That would drive long-term interest rates way too high with foreigners now net sellers. See the latest Treasury International Capital [TIC] figures. There you'll find total foreign holdings of Treasury notes and bonds are down 5% since February BCE. Nobody is interested in loaning trillions to the US government long term. Even if there was a market, there just is not enough liquidity. We are already seeing plenty of evidence of distressed long-term debt auctions and foreign demand slumping further. The latest 10Y auction was poorly subscribed and ended up pushing 10Y yields up 4 basis points on September 9. The 30Y auction back on August 13 was also poorly subscribed with the lowest bid-to-cover ratio since July 2019. Reuters on that auction reported that the Treasury, "plans to continue to shift more of its funding to longer-dated debt in coming quarters as it finances measures to offset the impact of the coronavirus epidemic."
In other words, the Treasury knows it cannot raise cash net with just T-bills and it has no other choice but to shift more of its funding to longer-dated debt. The big question is whether this can even last through "coming quarters" without upsetting the apple cart. In something of an understatement, one Zach Griffiths, an interest rate strategist at Wells Fargo in that article was quoted as saying, "I think this auction today shows there is at least a little bit of market indigestion with all of this new duration."
One More Multi trillion Spending Burst Could Do It
On top of that, we have the latest consumer bailout bill that will be probably somewhere around $2 trillion. Something like it will almost surely pass eventually, my guess after the elections if Trump wins, or after Biden takes office in January if he wins. (And if neither wins, we have bigger problems and a different potential trigger.) It's either that or deal with the political ramifications of mass evictions throughout the United States. Prevent that by executive order or legislation, and the problem shifts to mortgage-backed securities and the credit markets. The money for the bill if and when it passes will have to be raised quickly, and almost all of it in even more short-term bills of less than 6 months.
What happens then? The treadmill or hamster wheel or whatever you want to call this crazy situation could come off its hinges. This is looking more and more like the terminal stages of a Ponzi scheme. And this isn't just another Ponzi. This is the Ponzi. Bernie Madoff's $50 billion fraud is barely a drop in the ocean compared to this one.
Another reason that everything could fly off the hinges with one more $2 trillion bailout bill is that as noted above, there are only $2.82 trillion in total reserves in the entire United States banking system. Remember that little glitch thing in the overnight repo market back on September 17th dubbed the Repocalypse, before any of this COVID-19 mess even started? That was when suddenly bank reserves ran dry because the Treasury was sucking up too much liquidity and nobody in the central banking world saw it coming until it hit them square in the face, just like 2008 surprised them as well. Money markets froze up and overnight interest rates skyrocketed to 10% in a few hours. That's when the Fed's balance sheet started growing again.
So, given the mathematical constraints on funding substantially more short-term debt, if the next $2 trillion consumer bailout bill passes, the Fed is going to have to feed a lot more reserves into the banking system before these debt auctions even take place, or possibly face another repo crisis.
The Fed cannot buy short-term debt directly at auction. It is prohibited from buying on the primary market in this way. The Fed only owns $326.044 billion in T-bills on its balance sheet anyway, and hasn't added any since April. These are not a main part of its so-called "monetary policy tools". So it must expand its balance with more Treasury notes and bonds, its bread and butter securities. But how much more can the Fed even buy before it owns the whole caboodle?
Well, there are currently $13 trillion marketable notes and bonds outstanding. The Fed already owns $3.742 trillion of them (see table 5). Foreigners own another $3.759 trillion. (See TIC figures referenced above.) You can forget about those. If the Fed buys notes and bonds from foreigners, then we have much bigger problems on our hands than short-term government funding. All those trillions will get shipped back to the US and the dollar will drop like lead on the foreign exchange markets in a matter of days if not hours. That leaves another $5.5 trillion on the secondary market held domestically that the Fed could theoretically still buy. How much of it will even be left and how illiquid and volatile will the secondary Treasury market become if the Fed ends up owning most or even all of it?
Theater of the Absurd
This entire situation is completely absurd. It is ripe for a devastating explosion at any time. I do not believe it will be gradually unwound. Most likely it will end suddenly like a clap of thunder. This is why I do not think that consumer price inflation is going to slowly creep higher towards the Fed's contrived 2% average target in some gentle lazy river ride over the coming years. Consumer price inflation is going to explode higher violently and suddenly, in an ugly and frightening torrent that will begin in the foreign exchange markets and bleed quickly into domestic consumer prices when the prices of imports suddenly skyrocket in an international dollar collapse.
When the dollar index suddenly lurches down 5% or so in a day on a failed Treasury auction or the passage of the next bailout bill or Brexit being confirmed in October triggering a European banking crisis or a constitutional crisis in a contested presidential election in November or whatever exactly ends up happening, we will know the final end game has begun. Even if every trigger is somehow dodged, it does not change the math and this will eventually happen anyway.
Gold and silver will skyrocket suddenly in a way that will surprise even the most religious of gold bugs as the dollar gets dumped. Whatever ends up triggering it and whenever it finally happens, it is coming, and it will not be a slow process. Bubbles never deflate slowly. They explode. This one has been blowing up for 40 years since the bond market bottomed in 1981.
Buy gold, buy silver, buy real assets, get out of the dollar and all Treasuries and batten down the hatches before the storm begins. Strictly mathematically speaking, this absurd situation cannot possibly continue on for much longer.
Originally posted on Seeking Alpha