1. Turmoil in Overnight Markets
Treasury Bill settlements and purchases by primary dealers of approximately $78 billion contributed to turmoil in overnight markets in mid September 2019. Interest rates on Repo’s shot from approx. 2% to 10% on some issues.
The Federal Reserve was caught totally off guard and did an emergency, unplanned infusion of tens of billions of dollars into the system to stabilize markets. Later, the Fed announced an approx. $400 billion dollar program to purchase U.S. Treasury securities through summer 2020.
Federal Reserve Chairman Powell was asked at a January 29, 2020 FOMC press conference, do you have any greater sense of what was going wrong with the repo market starting in September, whether it was a one-off event, too tight around tax payments and debt settlement or whether there is a more enduring issue going on with the market, more structural forces that are basically gumming up their repo sector?
Chair Powell replied – We’ve done a ton of work. Actually, we don’t have anything to announce here today. But I feel good about what we learned there. I think you mentioned other factors, we will be announcing our finding. I’m not going to give you a time, but we’re well along in that assessment at this time.
“I think we found….” “We’ve learned….” Months later the Fed doesn’t have an answer.
When the Fed answers, its analysis needs to describe what it thinks would have happened in broader savings and investment markets if it had not intervened. If they conclude that it could have had a catastrophic impact, with a domino effect of spreading illiquidity, then one must conclude that the federal government’s demand for debt financing risks making the savings and investment markets fragile. Investors should be warned about this risk.
Also, there is a symbiotic relationship between rate spikes in the private markets and government debt management. If interest rates spike in private markets, it is highly likely that they will spike for Treasury securities at auction, making the federal government’s fiscal position all the more unmanageable.
This happend once – it can happen again!
2. U.S. Treasury Securities Yield Spikes
Extraordinary Measures are discontinued after budget impasses and abnormally large issuances of Treasury securities are placed into the market that adversely impact rates. The following amounts of Treasury securities issuances resulted in yield spikes – 2011 – $236 billion •2017 – $319 billion •2018 – $175 billion •2019 – $291 billion.
Yield spikes will likely repeat when the debt ceiling is restored in 2021, if not sooner due to an unanticipated event.