Banana Republic
The rise of the US Federal Debt in the last 20 years has been quite staggering, which has raised the US Treasury's "reinvestment risk" and will now require substantial "longer dated issuance". This post is simply to
- show the recent data (taken from the US Treasury and Federal Reserve), and
- highlight how recent past behaviour will give a very good guide to the future.
- show how the FED will continue buying more and more US Treasuries
It is hard not to be shocked by the numbers, and the US is by no means on its own - the same data and behavioural patterns can be seen in many "developed" countries in Europe (including the UK). As the conclusion shows, the FED will be forced to act more aggressively.
RECENT DATA
Charts below from the Fed Flow of Funds shows the rise of Federal and State debt since WW2, with the left chart showing the annual percentage increases and on the right as a % of GDP.
Three observations :
- Debt started its rise in the 1970s at the end of the Gold standard.
- Until the GFC in 2008, Debt/GDP remained relatively stable, and then moved sharply higher to plateau around 100% until Trump started his $1trn/year deficit spending in 2018 and 2019
- Fiscal policy to support the US economy in the Covid pandemic has brought a further jump in Federal and State debt, both in Nominal terms and in terms of debt/GDP.
The data and charts below represent only marketable US Federal debt, depicting the rise in debt and the ownership of the debt.
The chart and table below shows the annual increase in debt (in $bns, RHS), split between Domestic owners, foreigners and the Federal Reserve (% of total, LHS). The FED's role in large purchases of net supply in their QE programs is very clear.
I have seen estimates that the Federal debt will increase by a further ~$ 2trn in 2021 - whilst that would be half the 2020 increase, it would still be the second largest increase on record.
Recent Data Conclusion. There has been a vast amount of debt issuance
- following the 2008 crisis,
- due to Trump's $1trn 2018 and 2019 tax give away and
- more recently to support the US economy during the Covid pandemic.
The FED has purchased a large amount of bonds - this action looks everything but temporary in nature.
CONSEQUENCES OF A LARGER DEBT STOCK
When a Treasury function needs to raise a lot of money very quickly, it has to make recourse to the short term bill market and raid cash balances. That's what happened in 2008, and exactly what happened in 2020. Chart below shows the cumulative amount of Bill Issuance every year for the last 20 years, showing the huge issuance in 2008 and 2020.
The problem about issuing short term bonds is that they soon mature and need to be refinanced frequently. The numbers below show this "refinancing risk" very clearly - this is the one table that will keep Janet Yellen up at night. To put the numbers in the table below into perspective, consider that the annual US GDP is ~ $21trn.
The US Treasury had to issue almost $ 17 trillion of Bills in 2020 due to the huge issuance to fund the deficit AND to refinance a huge amount of redemptions - it will roughly the same story for Bills in 2021. Just as challenging, the UST had to issue 4 trillion of coupon paper in 2020. $4trn is equivalent to the TOTAL OUTSTANDING DEBT accumulated by the US from independence day in 1776 all the way up to 2005.
Following the huge issuance of Bills in 2008, the US Treasury had to issue large amounts of coupon paper in the following years to reduce this Bill refinancing risk (and thus try to extend the average life of the debt). Chart below shows the (12mth ma) monthly issuance of different coupon maturities between 2009 and 2012 - note the introduction of the 3 and 7 year bonds and rise in the monthly issuance amounts of other existing maturities.
This had the desired effect of raising the average maturity of outstanding debt between 2009 and 2015, even if the annual refinancing of Bills remained high at c. $5trn/year.
The chart above shows the impact of the huge bill issuance in 2020 on reducing the average debt maturity, which no doubt the US Treasury will want to rectify starting in 2021, by again issuing longer dated coupon paper. But its not that easy as two things are conspiring against them:
Because of the huge 2008/09 deficit and debt issuance, coupon paper has already increased substantially.
Trump's 2018 and 19 deficits caused a further rise in coupon issuance
The consequence of these two issues is that the US Treasury already issued a record amount of coupon issuance in 2020 (chart below).
Indeed 2021 will see record coupon issuance for three reasons:
- to refinance coupon bonds that will mature this year
- to extend the debt maturity by rolling Bill redemptions into new coupon paper
- to part finance (with Bill issuance) a large 2021 deficit.
CONCLUSION
In 2018 it was clear that Trump's excessive deficits would lead to debt refinancing risks that were similar to those of the Italian Tesoro following the 2011 peripheral crisis. This die was already cast before the Covid19 pandemic as the US private sector indebtedness was reaching saturation point and, just like in Japan, the government would have to support economic growth with fiscal policy. This is the "private to public debt growth switch" that I have discussed in previous posts.
The Covid pandemic has merely brought forward the day of reckoning that was already on the cards, simply because the private sector had no buffers and reserves for bad times, so the government had to step up to the plate.
The investor ramifications from this upcoming long dated debt issuance are huge. If the private sector has to finance this forthcoming tsunami of coupon issuance, you can bet that real yields will have to rise to attract those private sector savings away from private sector assets. This is exactly what 2018 was all about - real yields rose and stocks and corporate bonds got clobbered until the FED reversed its tapering exercise and started buying USTs in size.
My thoughts remain the same - see previous posts - the genie is out of the bottle and the Fed will of course come to the water and have to buy an ever larger amount of USTs to keep net supply and thus real yields low. This will be to try and keep financial assets afloat, which will of course allow bubbles to continue. The same will naturally occur in the Eurozone, UK and Japan. But take note from the previous charts, the increase in debt is NOT linear - the power of cumulation is at work.
Given the supply next year, it is fair to say that Central Bank QE had better NOT be temporary in nature, otherwise risk assets could move in a similar fashion to 4Q 2018 (when there was the terrible combination of large debt issuance, Fed unwinding its balance sheet and rising real yields). My guess is the FED and other Central Banks will continue to buy substantial amounts of debt, raising the question of what Temporary actually means.........and thus the title of the post.
Oxford English Dictionary
temporary Pronunciation /ˈtɛmp(ə)rəri/ ADJECTIVE Lasting for only a limited period of time; not permanent.
Updated monthly data on US Debt issuance and Fed balance sheet increases
Net supply to the market that has to be financed by foreigners and/or domestic savers
