The Debt Piles Up
- Billions in U.S. Treasuries piling up, unwanted and unloved…
- … but don’t get the wrong idea
- Brace for spillover from the next “flash crash”
- Is it safe to venture back into the precious metals waters?
- Checking on the Fed’s favorite inflation gauge… the war on cash’s 1970s origins… one place where cash and anonymity are still welcome… and more!
It’s a headline that inspires false hopes about politicians finally getting their comeuppance.
“Wall Street’s Pile of Unwanted Treasuries Exposes Market Cracks,” Bloomberg reported a week ago.
It seems the U.S. Treasury’s “primary dealers” are saddled with more Treasury debt now than at any time since October 2013. The primary dealers are the 22 big banks and trading firms required to show up at Treasury auctions in exchange for a host of special privileges with the government and the Federal Reserve.
The backwash is accumulating partly because foreign central banks are unloading Treasuries at a record pace — $105 billion in December and January.
It’s so easy — and tempting — to draw the wrong conclusions from this story.
Unwanted Treasuries? “Yes! We’ve reached the tipping point with a $19 trillion national debt! Finally, those foreigners are wising up and dumping Treasuries! Supply is overwhelming demand! Time to load up on TBT, the double-inverse Treasury ETF! I’ll make a fortune shorting Treasuries!”
Hold on, pardner. Once again, you’re falling into the trap of “just world” investing. Yes, if it were a just world, no one would want U.S. Treasury debt and TBT would be a sure bet.
If anything, these developments signal lower yields and higher prices on Treasuries.
Nearly a year ago in these virtual pages, Jim Rickards described a discussion he had with a banker who works with the Treasury Borrowing Advisory Committee — a private group that meets regularly with Treasury and Fed officials to grease the wheels of the Treasury market.
“Jim, it’s worse than you know,” said this highly connected individual. “Liquidity in many issues is almost nonexistent. We used to be able to move $50 million for a customer in a matter of minutes. Now it can take us days or weeks, depending on the type of securities involved.”
Much of that is a function of new rules put in place after the Panic of 2008. Government regulations being what they are, the effect has been to make the system more risky, not less.
But in the event of a dislocation, the most likely result is another “flash crash” like the one that occurred on Oct. 15, 2014 — when the yield on a 10-year note suddenly collapsed — sending prices higher — and then rebounded.
The real problem lies in the spillover effects — as Jim described to us last year.
Let’s return to that inventory of Treasuries held by the primary dealers. “These inventories are financed on a short-term basis,” Jim said, “sometimes overnight, using repurchase agreements — the so-called ‘repo market.’”
The repo market rate is close to the fed funds rate — that is, still less than half a percent. Meanwhile, 10-year Treasuries have traded with a yield-to-maturity of 2–3% since 2013. That’s a handsome spread for a primary dealer who buys 10-year notes and finances them in the repo markets. Leverage the trade 10:1 and the return on dealer equity can be north of 20%.
“But there’s a catch,” Jim goes on. “The dealer is financing a 10-year asset with overnight funds. If the repo rate rose sharply, the dealer could find that its profitable spread disappeared. In a worst case, the spread could go negative and the dealer might have to dump the 10-year note at a loss.”
Sure enough, stresses are showing up in the $1.6 trillion repo market — according to that very same Bloomberg story last week.
“The combination of dealer demand, a global government-debt rally and reduced auction sizes caused a shortage in the repo market for the securities needed to close short positions in 10-year debt. Failures to deliver 10-year notes surged in the week ended March 9 to the most since at least 2013. For all Treasuries, failures reached the highest since the financial crisis, New York Fed data show.”
Long story short, in the three weeks since, these stresses appear to have abated — this time.
But Jim anticipates one day there will be another flash crash in Treasury rates that won’t bounce back — setting off the next financial crisis.
“The solution for investors,” Jim said last year, “is to have some assets outside the traditional markets and outside the banking system. These assets could be physical gold, silver, land, fine art, private equity or other assets that don’t rely on traditional stock and bond markets for their valuation.”
[Ed. note: If you’re more aggressive-minded, you might wish to take on the sort of trades Jim recommends in Rickards’ Intelligence Triggers. Out of five trades closed so far in 2016, the average gain has been 46% across an average holding time of five months. That’s like doubling your money inside a year.
Discounted access to Rickards’ Intelligence Triggers is still available through midnight tonight. That means if you want to take advantage, it pays to move now.]
After a three-day weekend, it’s a sleepy Monday in the markets, the major U.S. stock indexes ruler-flat. As we write, the S&P 500 has shed a point at 2,034.
Gold is likewise quiet at $1,219 — not bad considering the dollar is losing ground to other major currencies. Treasury yields are little moved, the 10-year at 1.88%. If it’s excitement you’re looking for, it’s in crude — down a little over 1% at last check and back below the $39 level.
The Federal Reserve’s favorite inflation measure is taking a breather.
It’s “core PCE” the Fed watches most closely when deciding how close inflation is to its 2% target. The number spent much of 2015 on the mat, before suddenly racing up last fall and reaching 1.7% in January.
The Commerce Department is out today with the February number, and it’s leveled off.
The number will no doubt take the edge off some of the chatter late last week that the Fed might raise the fed funds rate at its next meeting in late April.
Meanwhile, the accompanying “income and spend” report reveals Americans are resuming their tightfisted ways of the last couple years. Personal incomes grew 0.2% in February, and that’s mostly a function of handouts — wages and salaries fell 0.1%.
Meanwhile, consumer spending grew at a slower pace than incomes, up 0.1%. And the January consumer spending figure was revised way down.
“Surprisingly weak” is how Econoday characterizes the report. Ya think?
“I think we’ll eventually look back and call December/January the ‘capitulation’ bottom,” says Byron King of the precious metals markets.
“Back then, there was no way to know what the new year would bring. Now, however, we can see a low-low point in the rearview mirror.
“At the same time, beware of backing up the truck and buying everything in sight just now. The recent precious metals rally hasn’t been a cyclical industrial turn so much as monetary driven, coupled with plenty of short squeezing.”
In other words, much of the recent rally is tied to negative interest rates in Japan and Europe. If bank deposits and government debt guarantee you’ll lose money, “that’s when people begin to buy hard assets like gold and silver,” says Byron, “along with high-quality mining shares.
“Near term, I’m concerned that the recent upswing in gold and silver prices might retreat for any of many reasons. I’m happy to take advantage of opportunity, of course, such as truly beaten-down share prices. But whatever you buy, don’t spend down all your cash fast. Keep some dry gunpowder.”
“As a ’70s technocrat, I remember the futurists declaring the coming ‘checkless, cashless society,’” writes a reader who reminds us the war on cash isn’t new.
“We all thought that it would be the greatest thing that could happen for those of us developing all of the necessary hardware, software and communications networks. We would all have lots of jobs until we retired.
“As for the medium, we failed to consider that it could somehow negatively impact spending prudence. How can we be against Santa Claus for little children? Having conned myself into bankruptcy once, and then almost a second time, I have been strictly all cash for 10 years now.
“I rejoice in the peace of mind of solvency almost every day. When asked how I am going to pay for something, often to their astonishment, I answer: ‘With money.’ I smile to myself knowing that I am using the ultimate cash-back program. Extra bonus: When I give a server a tip, I know that they are getting all of it.”
The 5: Reminiscent of the advice Stephen Pollan gave nearly 20 years ago in the personal finance book Die Broke. Wonder if his famous children Michael (the author) and Tracy (the actress) follow it…
“If you have bills to pay, and cash on hand to pay it, but do not want to deposit it into your checking account, I have another option,” write a resourceful reader: “Get a money order from your local Western Union.
“I have walked in with $2,000 cash and walked out with $2,000 in money orders. It’s 79 cents for each money order, a $1,000 limit on a single money order. No questions asked, no ID required. For now, anyway.
“I would also advise if you walk around with a cash bulge in your pants to make sure you have another bulge from your heat. Licensed, of course!”
“It is an interesting fact,” a reader writes about dollar coins, “that coins are issued by the U.S. Treasury and paper bills are issued by the Federal Reserve. Federal Reserve notes are instruments of debt, while coins are not.
“We could save huge amounts of interest if we went to a dollar coin. Good for the public, but not for the private owners of the Fed! Maybe that’s why the dollar coin has never gotten traction. Just thinking!”
The 5: Hmmm… We’re not sure about the mechanics of that, seeing as most of the unwanted dollar coins sit in a Federal Reserve warehouse somewhere here in Baltimore…
“And so the reader now understands what gave rise to Prop 13 in California ages ago,” says an email about property taxes. “Way back when, the real issue was retirees being forced out of their houses by the exorbitant rise of California property taxes.”
“If Prop 13 hadn’t passed,” writes a California reader, “I would never have been able to purchase the home we bought in 1974. Even today, the limit on property taxes helps us stay in our home through our retirement years. Yes, the amounts have risen. Still, we have not been priced out of our homes.”
“The 5 is a must-read every day… keep it coming!” writes our final correspondent. “So full of insights… and humorous too.”
The 5: You must be new. Where’s the “but”?
The 5 Min. Forecast
P.S. Congratulations to readers of Rickards’ Intelligence Triggers: While we were penning today’s episode of The 5, they got a sell recommendation — good for 180% gains in 2½ months.
That brings the average closed position this year up to a 69% gain across a hold time of less than five months.
Final reminder: Discounted access to Rickards’ Intelligence Triggers expires tonight at midnight. Grab it while you can.