A Rating Agency Responds to the US Money Printing Exercise – Halyard’s Weekly Wrap – 8/4/23

The July employment report showed that the economy generated 187,000 jobs in the period versus consensus expectation of 200,000 while recording a downward revision to the two prior months totaling 49,000.  Wage growth as shown by average hourly earnings remained solid for the month – indicating that the slowdown in hiring is a reflection of a tight labor supply.  Two Fed officials spoke post the non-farm payroll report and both indicated that the path of employment and inflation were heading in the right direction and that dialogue may shift from whether to raise rates to how long do rates need to remain at the current level.  Bond prices rose in a relief rally, removing the past week’s rise in the yields in 2yr and 5 yr Notes.

The Treasury Department announced the 2023 third quarter borrowing plan this week and one money-center bank described it as a “Treasury tsunami.”  What they were referring to is ballooning budget deficit and the need for the Treasury Department to sell Treasury bills, notes, and bonds to finance it.  Approximately $254 billion of Treasury coupon notes and bonds were issued this past June.  The Treasury Department said the number will rise to $270 billion this month and will rise further to $281 billion this October.  Based on that October amount, the annualized issuance equates to $3.37 trillion, if the deficit does not rise further.  The runaway deficit spending, paired with debt ceiling stalemate last month was what prompted Fitch debt rating service to downgrade the credit rating of the United States to AA+ from AAA.  Treasury Secretary Yellen said the decision was “puzzling in light of the economic strength we see in the United States.”  We’ll try to solve the puzzle for her; the debt to GDP ratio, a measure of solvency, has ballooned since the 2008 financial crisis, then soared well above 100% during the pandemic.  According to the Saint Louis Federal Reserve, the Debt-to GDP ratio currently stands at approximately 120%.  To put that in perspective, the ratio wavered between 35% and 65% prior to 2008.  Hopefully, that helps Secretary Yellen to understand the basis of the downgrade.

The Treasury Department also announced the intention to commence a Treasury buy-back operation in Q1 2024 as a means of “liquidity support.”  Bond dealers have complained that older notes and bonds have a wide bid-ask spread.  Treasury responded by announcing that they will buy back a maximum of $30 billion a quarter in an effort to help reduce the transaction expense of older issues.  To summarize, Treasury is significantly boosting the debt they auction going forward but buying some of that debt back in the open market (to appease the dealers), while the Federal Reserve continues to let its portfolio of Treasury and mortgage debt run off.  We have a suggestion for the U.S. government; stop giving money away and the Fed and Treasury won’t need to scheme to make the rates market functional!