The small thump you heard yesterday was the US Treasury hitting the debt limit. As expected by most, the sky did not fall, but lest you be too sanguine, a series of events have been triggered that could affect many farmers.
First, foreign investors, who hold nearly half of outstanding Treasury debt, could reduce their purchases of Treasuries on a permanent basis, and potentially even sell some of their existing holdings. A worrisome precedent is the sharp decline in foreign sponsorship of [government-sponsored enterprise, or G.S.E.] debt since Fannie Mae and Freddie Mac were placed under conservatorship. Despite assurances from Treasury officials regarding the U.S. commitment to these institutions, foreign sponsorship has yet to return to pre-conservatorship levels. If foreigners began curtailing their investment in Treasuries as a result of a default, Treasury rates, and thus Treasury’s borrowing costs, would undoubtedly rise. A sustained 50 basis point increase in Treasury rates would eventually cost U.S. taxpayers an additional $75 billion each year. [More]While the focus here is Fannie and Freddie, don't forget the Farm Credit System is a GSE as well. The longer this game is prolonged, the more problematic its bonding power could become. And if we slip to deeper levels of default beyond the euphemistically labeled "technical default", at some point the implied guarantee of FCS paper becomes worth much less, if not zero.
The POMO schedule for next week calls for only $15-22 billion in gross aid. Because $6 billion in GSE paper will mature, net POMO will total “just” $9-15 billion, so the market’s performance in light of that should give us an interesting perspective. If the market can’t hold up with $9-15 billion of support from the Fed, how will it do with none?No, I won't pretend I grasp that, but it seems semi-obvious that nobody truly knows what will happen in the debt markets. we've never charged down this road before. Although after the Lehman Bros. collapse, FCS funding was a struggle at best.
On the other hand, the debt ceiling issue looms, and I don’t presume to know how that will play out. It’s a contaminating factor insofar as making any judgment about the influence of reduced POMO. This problem needs to be resolved so that we can get back to the of analyzing this mess in a more “pristine” environment.
Primary dealers are handing over their long term Treasury paper to the Fed as fast as the Fed will take it, and interestingly the dealers are not replacing it. PD inventory of Treasuries is crashing. This looks like distribution. They're piling up cash at a breakneck pace. But to what end? Are they preparing for the apocalypse come the end of June, or are they preparing to buy massive amounts of Treasury paper once the Fed leaves the market. The answer to that is a no-brainer, but the Street wants us to believe otherwise.
Wall Street keeps telling us that there will be plenty of buyers for Treasuries once the Fed stops POMO. All the evidence that I now see points in exactly the opposite direction. Not only are the PDs treating Treasury paper like last week’s garbage, banks in general are also dumping the stuff. Only foreign have been good public servants picking up tons of the stuff in recent weeks, but even that appears to have stopped. If they go on strike, it will be a catastrophe for the market. [More]
But I thought "uncertainty" was the favored cause of sluggish business investment. And it was caused by the Obama administration policies. Why aren't Republicans in Congress horrified at the thought of all this real and debilitating uncertainty in the bond market - which they are seemingly happy to provoke?
Nevertheless, Republican leaders view this as a “leverage moment,” to borrow House Majority Leader Eric Cantor’s phrase. They figure that they can extract maximum concessions from the self-styled adult in the room (President Obama) by pushing as close to the edge of the cliff as possible. On Wednesday Cantor upped his leverage moment ante by declaring that the House GOP "will not grant [the] request for a debt limit increase" without major spending cuts or other concessions. As Politico reports, "In the most recent budget battle–over a six-month spending bill–Republican leaders carefully avoided threatening to shut down the government. Now, Cantor says he’s ready to plunge the nation into default if the GOP’s demands are not met." So they’re more willing to flirt with "financial disaster" than they were to talk about government shutdown. Wonderful.
[Read the U.S. News debate: Should Congress raise the national debt limit?]
Which brings us back to the concept of uncertainty. If there’s one thing businesses and Wall Street like less than uncertainty about whether taxes might go up, it’s uncertainty about things like “financial disaster.” They prefer that we not be making a bee line for a cliff at all, because of the attendant uncertainty about the politicians’ ability to avoid driving off of it. [Check out political cartoons about the economy.]
Specifically, while Boehner has tried to explain to Wall Street types the politics of this ‘leverage moment,’ they have shot back that the debt ceiling vote (and the possibility of “financial disaster”) really isn’t something pols should be mucking around with. And it’s not just the Wall Street money wizards who are telling the GOP to quit it: Main Street business groups like the U.S. Chamber of Commerce and the National Association of Manufacturers are also lining up in the don’t-play-politics-with-the-debt-limit camp (h/t Steve Benen). [More]
Beyond the possible FCS hiccup, I think uncertainty is the word dof the day for our commodity markets as well. I also think there is greater downside than up, as panicky money starts running for cover.
I think this is a moment of greater peril than most realize simply because our financial is so complex it may be impossible to predict. Lord knows we haven't done well the past few years. Like kids playing with explosives, we only have the vagues idea of the interlinkages that could bring down even seemingly unrelated financial activities.
In short, I think we have just entered a "What-were-we-thinking?" moment.