This week something happened that, at first glance, may seem technical, but could end up being much more important: the U.S. Treasury decided to double, at a minimum, its long-term bond repurchases, raising the maximum per operation from US $2 billion to US $4 billion for securities maturing in 10 to 30 years. The measure begins on September 9 and, for now, will be in effect until early November.
Formally, the Treasury's argument is to improve market liquidity. But the timing chosen is impossible to ignore. The 30-year Treasury yield had just reached levels not seen in nearly two decades. And when the decision was announced, the reaction was immediate: bonds rose, long-term rates fell, the dollar dropped, and gold surged.
In other words, the market quickly interpreted the message: the U.S. government is concerned about long-term rates at these levels. And it has reasons to be.
The United States has just surpassed US$40 trillion in public debt, maintains enormous fiscal deficits, and needs to constantly refinance a mountain of maturities. The higher the rates remain, the greater the cost of refinancing that debt and the larger the interest burden that ends up feeding the deficit.
The problem is that this Treasury intervention is relatively small compared to the size of the market. In fact, after the initial reaction, rates rose again. The 30-year Treasury ended the week around 5.28%.
And this is where the important question arises:
What happens if US$4 billion per operation is not enough?
From the Treasury to the Federal Reserve
Today we are not talking about QE. We are also not talking about Yield Curve Control. And the Federal Reserve is not announcing bond purchases to lower long-term rates.
But the precedent that has just been set matters.
The Treasury has just demonstrated that, in the face of a sufficiently uncomfortable rise in long-term rates, it is willing to intervene by buying bonds.
If pressures continue, the next step could be to increase those repurchases even more. And in a more extreme scenario, if the market demanded rates incompatible with fiscal sustainability, the institution with real firepower to intervene would be the Federal Reserve.
At that point, we would enter completely different territory.
The Fed could expand its balance sheet again by buying Treasuries, as it did with quantitative easing. And, in the extreme, some variant of Yield Curve Control could emerge: a policy aimed at preventing certain long-term rates from exceeding levels deemed intolerable.
It would, in effect, be a choice between two problems:
allowing the market to determine increasingly higher rates or using monetary creation to contain them.
And for gold, silver, and other real assets, that difference is enormous.
The problem of foreign buyers
Additionally, the United States needs to issue more and more debt just as some of its historical foreign buyers are reducing their exposure.
Japan remains the largest foreign holder, but its Treasuries fell from approximately US $1.24 trillion in February to US $1.12 trillion in June.
China is also continuing to sell. Its holdings have decreased to approximately US$633 billion, the lowest level since 2008.
