U.S. Treasury Yields Near 4%, Global Sell-Off Continues
As U.S. Treasury yields approach 4%, the Federal Reserve faces a dilemma while global sell-offs continue, raising fears of an impending crisis.
While the U.S. Treasury market is not yet in catastrophic collapse, a troubling trend has emerged: the 10-year Treasury yield has risen persistently, crossing the critical 3.9% threshold and inching closer to 4%. This surge begs the question: isn't a rising yield indicative of a healthy investment? It's crucial to consider the underlying reasons for such elevated yields. Increased yields typically signal a lack of demand, and countries like China and Japan continue to offload their holdings. Will U.S. debt eventually plummet? If a catastrophe were to unfold, what consequences would follow? In this article, we will model the potential collapse of U.S. Treasuries, equipping readers with the foresight to prepare for fallout and mitigate its impact. Are you ready? Let’s delve into this pressing issue!
I have previously discussed the concept of "national debt." Any sovereign nation can issue bonds, much like an individual borrowing money. However, there’s a significant difference: personal loans generally come with a defined term—most mortgages, for instance, do not extend beyond thirty years. This limitation stems from the finite nature of human life; even the healthiest individuals will eventually retire and cease earning a steady income, making it harder to repay debts.
Conversely, countries operate differently. As long as a nation exists, its debts transfer to subsequent governments, allowing national bonds to theoretically extend indefinitely, often referred to as "perpetual bonds."
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So, what does "perpetual bond" mean? It implies that as long as the borrower can meet interest payments, these bonds can keep rolling over indefinitely. Many bondholders patiently collect their interest like clockwork. Due to its substantial global influence, U.S. Treasuries have long been seen as a sought-after investment, instilling faith in their reliability. Investors have historically viewed American bonds as a safe haven, particularly during periods of rising interest rates, reinforcing their position in the global financial system.
However, even the most beloved investment can face adversity. Since 2022, U.S. Treasuries have lost some of their luster. Just days ago, the 10-year Treasury yield surged past 3.9%, edging closer to the 4% mark. This rising yield is not a positive development; rather, it reflects increasing sell-offs in the Treasury market.
Here's the underlying economic principle: the yield on U.S. Treasuries is inversely related to their price. If we treat U.S. bonds as products in the marketplace, when demand is strong and supply is limited, prices rise, leading yields to fall. Conversely, when interest wanes and there's an abundance of products to sell, prices drop, leading to higher yields. The current spike in the 10-year yield correlates with waning interest in U.S. debt, indicating a period where bonds are being heavily offloaded.
The ongoing reduction in U.S. Treasury holdings stems from factors within the U.S. itself. Although buyers initially gravitated towards Treasuries for their stability and returns, the relentless growth of national debt raises concerns. If the debt becomes unmanageable, it may resemble an inflated balloon—one that could burst at some point, creating a scenario every investor fears the most.
As of now, the U.S. national debt has surpassed the statutory ceiling of $31.4 trillion set by Congress. This figure, when spread across the American population, amounts to approximately $100,000 per person, equating to over 700,000 RMB—a staggering sum by any estimate.
With colossal debt comes colossal interest payments, amounting to trillions annually. The challenges presented by the COVID-19 pandemic led the Federal Reserve to implement aggressive monetary policies. Even as government debt remained below $20 trillion, the $31 trillion figure loomed large, prompting debates in Congress over whether to raise the debt ceiling further, delaying resolution. This leads us to consider the consequences should U.S. Treasuries fail—one we can explore through a three-stage prediction that illustrates how the U.S. could inch toward economic calamity.
Stage One: Ongoing Global Sell-Offs and a Halt to Fed Interest Rate Increases
The contradictions surrounding U.S. Treasuries will ultimately bring attention back to the Federal Reserve. The U.S. administration has been increasing its debt exposure by issuing more and more bonds to acquire dollars for government expenditures. Recent initiatives include numerous subsidy programs for renewable energy companies and semiconductor manufacturers, all funded in part by those bonds. However, the Fed’s interest rate hikes essentially restrict dollar flow into the economy, favoring financial institutions instead and discouraging bond issuance.
However, the government and the Fed often have diverging interests. Despite the Fed’s central banking role, it operates as a private institution. Attempts by the government to recapture the authority to print currency have historically met fierce resistance, revealing that control over monetary policy is far from absolute.
Currently, the Fed’s most pressing issue appears to be domestic inflation, measured by the consumer price index, which saw a 6% year-over-year increase as of February. While the rate of increase has declined over recent months, the Fed’s 2% target remains a distant goal.
The Fed insisted that without tangible reductions in inflation, interest hikes would persist. However, with inflation remaining stubbornly elevated, the resistance to further hikes is mounting:
On the one hand, the American financial system is encountering substantial issues, with the collapse of Silicon Valley Bank representing a crucial indicator. Just days after its stock re-entered the market, shares plunged 99%, shocking investors across the board. Financial crises act like contagions, quickly spreading to other mid-sized banks and impacting major institutions like Credit Suisse and Deutsche Bank, resulting in widespread declines in stock prices.
Initially, the U.S. Treasury and the Fed attempted to alleviate concerns publically by announcing plans to provide liquidity to banks. Yet, regardless of the Fed's response, the market had already cast its vote. The stock price of Silicon Valley Bank plummeted from above $300 to below $1, leaving shareholders devastated.
On the other hand, as mentioned earlier, American bonds are losing favor. Should the Fed continue to raise rates, the influx of dollars into the financial system will intensify, leading to further declines in Treasury values and potential liquidity crises—escalating the risk of a Treasury collapse.
Caught between a rock and a hard place, the Fed finds itself navigating treacherous terrain. The need to halt rate increases becomes apparent as they cannot afford to witness a Treasury collapse.
Stage Two: American Allies Take a Hit
Even if the Fed halts interest hikes, the U.S. Treasury crisis would still loom large. In 2022, China’s holdings of U.S. Treasuries plummeted from approximately $1.07 trillion to $860 billion, while Japan, a U.S. ally, offloaded over $220 billion. After these two major holders, countries like France, Belgium, Saudi Arabia, and Luxembourg also began reducing their Treasury holdings. International cooperation around selling off U.S. debt seems to have silently emerged.
Buying and selling are interrelated; if everyone is selling U.S. bonds and no one is buying, a financial stampede could ensue. This mirrors plummeting stock prices, with the consequence being bonds offered at discounted rates, a trend that poses serious risks, leading to financial disasters, according to U.S. Treasury Secretary Janet Yellen.
Thus, to stabilize lending and prevent a market avalanche, the U.S. must locate purchasers for these bonds. Finding these buyers presents a challenge, however.
Nations facing economic difficulties lack the resources to purchase, while those with poor diplomatic relationships are unlikely to buy either. Ideal buyers are U.S. allies, particularly European nations, Japan, and South Korea. These countries, known for their strong ties with the U.S., stand out as potential purchasers.
In January 2023, Japan reversed its trend and began adding approximately $28 billion in U.S. Treasuries. This move raises questions regarding Japan’s motivations, especially since this was not influenced by U.S. prompts.
That said, the relationship between the U.S. and its allies is not ironclad. Historically, their interactions oscillate between cooperation and conflict. Even with shared policies and interests, internal disputes can lead to significant rifts, especially considering recent global hardships.
Stage Three: U.S. Treasuries Officially Collapse, and National Credibility Erodes
Should suitable buyers emerge to rescue the U.S. government afloat, authorities could mitigate the crisis. But typically, events rarely abide by established narratives. In the event of a complete Treasury collapse, no party stands exempt.
The first to recognize a Treasuries crisis will be credit rating agencies, notably the leading three: S&P, Moody’s, and Fitch. They will likely issue immediate downgrades of U.S. sovereign credit ratings, potentially placing the nation on negative watchlists.
Some may question the objectivity of these agencies since the ratings are predominantly operated by Western interests. However, history has shown that American creditworthiness has faced downgrades before.
In 2011, the U.S. Treasury reached a crucial juncture as debt approached a $14 trillion ceiling. The debate around raising this limit raged between Democrats and Republicans. As the stalemate dragged on, the government found itself cash-strapped, leading prominent agencies to downgrade U.S. credit ratings, triggering widespread panic among investors. An alarming $1 trillion in Treasury sales occurred within days, rattling the American financial market and nearly inducing a new financial crisis.
Fast forward twelve years, and the national debt has surged over double that amount, intensifying risks surrounding U.S. Treasuries. A marked downgrading of American creditworthiness could tumble the foundations upon which the “U.S. credit” rests, causing dollar-denominated assets to accrue substantial devaluation, potentially leading to worthlessness.
As we arrive at this juncture, it becomes evident that if the scenario were to materialize, no nation could escape the repercussions of a failure to trust in U.S. Treasuries. If you find yourself holding dollar-denominated assets, now is the time to begin preparing for potential risks as the Treasury crisis could affect all of us.