TheChek News Flow

U.S. government could face borrowing at rates near 6%, up from 0.1% less than two years ago

Investors are bracing for a flood of more than $1 trillion of Treasury bills in the wake of the debt-ceiling fight, potentially sparking a new bout of volatility in financial markets.

Some on Wall Street fear that roughly $850 billion in bond issuance that was shelved until a debt-ceiling deal was passed—sales expected between now and the end of September, according to JPMorgan analysts—will overwhelm buyers, jolting markets and raising short-term borrowing costs.

Few expect major upheaval, but many worry about the potential for unforeseen problems in the financial plumbing—where trillions of dollars worth of transactions occur daily—that could send tremors throughout markets. Many remember how money-market rates skyrocketed in 2019 during a period of low liquidity, necessitating intervention by the Federal Reserve.

“When you dump a tremendous amount of debt into the market, it causes dislocation,” said Jon Maier, chief investment officer of Global X, an exchange-traded fund provider. “Investors are underestimating that.”

In recent months, markets have been relatively placid. The S&P 500 has gained 12% this year, buttressed by a resilient labor market, the AI-led tech stock rally, and signs that the Federal Reserve is entering the final stages of its interest-rate campaign. The Cboe Volatility Index, known as Wall Street’s fear gauge because it measures the price of options that investors often use to protect against stock declines, is now hovering at multiyear lows.

The calm comes even as short-term bond yields have already jumped in recent weeks, lifted by expectations for the Fed to hold rates higher for longer. The two-year yield finished Tuesday at 4.523%, up nearly 0.8 point from its year-to-date lows seen a month ago. The 10-year ended at 3.699%.

Now the Treasury Department is rapidly replenishing its coffers. A weaker-than-expected tax season, coupled with “extraordinary measures” enacted during the debt-ceiling fight to keep paying the government’s bills, has drained its checking account held at the Fed to below $50 billion as of the end of May. Officials last said it was targeting a balance of $600 billion for what’s known as the Treasury General Account, or TGA.

That could weigh on the large banks that are required to bid for Treasurys at auction through an agreement with the government as the so-called primary dealers could be effectively forced to finance the replenishment of the TGA. At the same time, regulators are seeking to boost banks’ cash buffers to avoid another banking crisis. Further draining liquidity from markets, the Fed is allowing its balance sheet to shrink.

But even if banks pulled back from short-term funding markets, history suggests Fed officials would quickly extinguish any fires. In September 2019, the central bank unveiled a facility to provide banks with cash even though the rate spike’s cause was unclear. That facility, which brought down rates almost immediately, now exists as a permanent safeguard to help maintain the Fed’s rein on rates.

“It’s that unintended, unexamined, event that causes a clogging up of the financial plumbing,” said Joseph Brusuelas, principal and chief economist at RSM US. “That doesn’t mean the doomsayers are right—if a hiccup occurs, the Fed will step in.”

The latest program for at-risk banks, created during the March regional banking panic, reiterated the Fed’s willingness to come to the banking system’s aid, some analysts said.

The best-case scenario, according to strategists, is if money-market funds step up as the primary financiers of this round of bond issuance. Such funds, which invest much of their more than $5 trillion in short-term safe assets, could absorb a sizable chunk of the supply by yanking the $2.1 trillion they have parked at the Fed’s overnight reverse repurchase facility, known as a reverse repo. That would likely limit any blow to broader markets.

To make that happen, however, the government needs to attract them away from the Fed’s highly safe daily facility by offering higher yields on T-bills. When the Treasury issued more than $1.3 trillion of those bonds in April 2020, rates on 3-month bills rose 0.20 percentage point above the secured overnight financing rate—SOFR—a key benchmark for overnight lending.

According to Deutsche Bank analysts, bill yields could widen 0.10 to 0.15 point above SOFR this time around but are unlikely to go higher. Potentially complicating the comparison, analysts say, is this issuance comes at a time when markets lack the central bank’s support.

Given the Fed offers 5.05% at its reverse repo rate facility—which would increase if it upped the fed-funds target range—the U.S. government could be stuck borrowing more than $1 trillion at rates approaching 6%. A year-and-a-half ago, the U.S. could borrow in the same market for 0.1%, Treasury Department data show.

Treasury Secretary Janet Yellen warned Congress that the government’s increased funding costs due to debt-ceiling uncertainty gave cause for concern. Now, the sheer size of issuance is likely to drive up those costs, even with the debt-ceiling deal completed.

But not everyone sees the issuance triggering market turbulence.

“Anything that’s a one-off, complicated arcane monetary-policy plumbing issue gets resolved rather quickly,” said Marko Papic, chief strategist at the Clocktower Group.

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If the country’s shift towards economic orthodoxy is real, credible steps need to be taken quickly

Signs that newly re-elected Turkish president Recep Tayyip Erdoğan is willing to move away from unorthodox economic policies has led to an increase in investor optimism towards his country.

These developments are encouraging but investors should not underestimate the size of the adjustment that Turkey’s economy needs to make and the risk that Erdoğan reverses course before the policy shift really takes off.

Turkey’s economy is in desperate need of a policy adjustment. Low interest rates and restrictive foreign currency regulations have resulted in the build-up of large economic imbalances, including high inflation, a wide current account deficit and an overvalued exchange rate.

Rumours had been circling that Erdoğan may moderate his economic policies if re-elected. The appointment of Mehmet Şimşek as treasury and finance minister is the first convincing sign that a shift towards orthodox economic policymaking may be on the cards. Şimşek is highly regarded by investors and markets have reacted favourably to his appointment — the cost of Turkey’s five-year credit default swaps, which act as insurance against a sovereign default, has fallen sharply.

It’s unclear why Erdoğan has suddenly had a change of heart. Perhaps he has realised that current policy is unsustainable and that a strategy of growth at all costs is no longer needed with the election out of the way. Whatever the reason, officials are now working hard to rebuild credibility. Şimşek’s remarks over the weekend ticked a lot of boxes: commitment to fiscal discipline, price stability and reference to more “rational” policies.

If this is a real shift towards orthodoxy, credible steps need to be taken quickly. Among the first will be loosening policymakers’ grip on the currency. Various foreign currency restrictions and central bank interventions have been used to prop up the lira at an artificially strong level in recent months. These were successful ahead of the election, but have come with a cost: the central bank’s foreign exchange reserves, which were already at dangerously low levels, have fallen even further and Turkey has lost a lot of export competitiveness.

Policymakers wanting a sustainable turnaround in the current account and to attract foreign capital cannot hope to achieve this without a competitive exchange rate. Turkey needs a significant adjustment in the lira, both in nominal and real terms. A faster pace of depreciation would be a welcome sign that policymakers are easing back interventions and letting the currency return towards fair value. But the size of the required currency adjustment will be substantial. Inflation will be higher than otherwise and large and disorderly currency falls may cause strains in the private sector.

The next key step will need to involve a shift in policy at the central bank. A new central bank governor is a minimum. Whoever takes the job will need to be given the freedom to raise interest rates sharply. The experience in emerging markets is that it takes many years of high real interest rates to bring inflation back to single digits. Navigating the political hurdles to do it could prove a significant challenge.

All of this was hard to imagine a few weeks ago, but there are still unanswered questions. Will this be a half-baked policy shift in which interest rates are raised only gradually? Is it a temporary strategy to buy policymakers time while external financing strains remain so acute? Erdoğan’s abrupt sacking of central bank governor Naci Agbal in 2021, after he raised interest rates, is a cautionary tale about the dangers of getting too carried away with optimism on sensible appointments too quickly.

If Ankara embarks on a path towards orthodoxy, the medium-term outlook for the economy could be transformed. The lira’s decade-long depreciation largely reflects the wide gap between Turkish and global inflation rates and the excess that investors have demanded to compensate for holding the currency. Policies that reverse these trends have the potential to break Turkey out of the high inflation-currency depreciation trap that it has been in for years.

For now, a key focus is making sure that this policy shift sticks. So long as power is concentrated in Erdoğan’s hands, the threat that he calls an end to orthodoxy at any time will remain. This is likely to stay embedded in the risk premia on Turkish assets. If Erdoğan’s shift proves only temporary, Turkey goes back to square one. A severe currency crisis would become a bigger threat and this could ultimately cause major strains in the banking sector and, perhaps most worryingly, the public finances.

The $3bn reasons for a shock peace in golf

Saudi Arabia’s Public Investment Fund has made frequent appearances in DD for its role in some of the wildest moments in business and finance over the past few years. Who can forget Elon Musk’s “funding secured” tweet in 2018 or the spectacular misfired bets on SoftBank’s Vision Fund?

While Masayoshi Son’s portfolio didn’t pan out, Saudi Arabia has made serious progress in commandeering the world’s most popular sports. 

The latest example came on Tuesday when PIF-backed LIV Golf and the PGA Tour said they would merge and become partners, ending a yearlong battle between the two golf leagues that was mired in litigation and mudslinging.

Saudi-backed LIV emerged on the golf scene last year spending hundreds of millions of dollars to lure top golfers such as Brooks Koepka, Phil Mickelson and Dustin Johnson to join its breakaway league. It has threatened the PGA’s dominance of golf and put top industry figures on the defensive.

But PGA commissioner Jay Monahan and Yasir al-Rumayyan, head of Saudi Arabia’s sovereign wealth fund, recently began to privately hash out a resolution between their organisations over rounds of golf and meals in Venice, they told DD.

Crucial to the truce is an increasingly common asset wielded by Saudi Arabia in the sports world: cash.

PIF is set to pump billions of dollars into the combined PGA and LIV, which has yet to be given a new name.

The infusion, which some people involved said could amount to about $3bn, underscores how Saudi Arabia has muscled into global sports using oil-funded state finances.

Another breakthrough for Saudi Arabia came last month when Newcastle United, the English Premier League football team it acquired in 2021, qualified for the lucrative Champions League competition.

Its ambition in sports does not stop there. The Saudi government earlier this week transferred majority holdings in four Saudi football teams to the PIF, a manoeuvre many speculate is aimed at creating a powerhouse domestic league with the resources to lure top footballers like Karim Benzema and Lionel Messi.

Some top Wall Street figures helped to broker the once unthinkable truce in golf.

Investment banker Michael Klein and British business figure Amanda Staveley represented Saudi Arabia, while Jimmy Dunne, a founder and managing partner of Sandler O’Neill + Partners, and Ed Herlihy, co-chair of Wachtell, Lipton, Rosen & Katz, advised the PGA.

“As we were competing over the last couple of years . . . I think it’s fair to say that we couldn’t have imagined we’d have gotten to this point,” Monahan told the Financial Times. 

But the fact that Saudi Arabia has prevailed underscores the merit of its bet that money will ultimately win in the world of sports.

Keynes knew

The US dollar, analysts often propose, is the latest in a 600-year history of global reserve currencies. Each of its predecessor currencies was eventually replaced by another, and in the same way the dollar will eventually be replaced by one or more currencies.

 The problem with this argument, however, is that there is no such history. The role of the US dollar in the global system of trade and capital flows is unprecedented, mainly because of the unprecedented role the US economy plays in global trade and capital imbalances. The fact that so many analysts base their claims on this putative history only shows just how confused the discussion has been.

 It’s not that there haven’t been other important currencies before the dollar. The history of the world is replete with famous currencies, but these played a very different role in the flow of capital and goods across international borders. Trade before the days of dollar dominance was ultimately settled in gold or silver. A country’s currency could only be a “major” trade currency to the extent that its gold and silver coins were widely accepted as unadulterated or, by the 19th century, if the convertibility of its paper claims into gold or silver was highly credible.

 This is not just a technical difference. A world in which trade is denominated in gold or silver, or in claims that are easily and quickly convertible into gold and silver, creates very different conditions from those today. Consider the widely-held belief that sterling once ruled the world in much the same way the dollar does today.

 It simply isn’t true. While sterling was indeed used more than other currencies in Europe to settle trade, and the credibility of its conversion into gold was hard-earned by the Bank of England after the Napoleonic wars, whenever sterling claims rose relative to the amount of gold held by the Bank of England, its credibility was undermined. In that case foreigners tended to reverse their use of sterling, forcing the Bank of England to raise interest rates and adjust demand to regain gold reserves.¹

This does not happen to the US dollar. Trade conditions under gold- or silver-standards are dramatically different from those in a dollar world in at least three important ways. First, trade imbalances in the former must be consistent with the ability of economies to absorb gold and silver inflows and outflows. This means that while small imbalances were possible to the extent that they allowed wealthier economies to fund productive investment in developing economies, this was not the case for large, persistent trade imbalances — except under extraordinary circumstances.²

 Second, and much more importantly, as trade imbalances reverse, the contraction in demand required in deficit countries is matched by an expansion in demand in surplus countries. That is because while monetary outflows in deficit countries force them to curtail domestic demand to stem the outflows, the corresponding inflows into the surplus countries cause an automatic expansion of domestic money and credit that, in turn, boosts domestic demand. Under the gold- and silver-standards, in other words, trade imbalances did not put downward pressure on global demand, and so global trade expansion typically led to global demand expansion.

And third, under gold and silver standards it was trade that drove the capital account, not vice versa as it is today. While traders chose which currency it was most convenient in which to trade, shifting from the use of one currency to another had barely any impact on the underlying structure of trade.

None of these conditions hold in our dollar-based global trading system because of the transformational role played by the US economy. Because of its deep and flexible financial system, and its well-governed asset markets, the US — and other anglophone economies with similar conditions, eg the UK, Canada, and Australia — are the preferred location into which surplus countries dump their excess savings.

Contrary to traditional trade theory, in which a well-functioning trading system might involve small, manageable capital flows from advanced, capital-intensive economies to capital-poor developing economies with high investment needs, nearly 70-80 per cent of all the excess savings — from both advanced and developing economies — is directed into the wealthy anglophone economies. These in turn have to run the corresponding deficits of which the US alone typically absorbs more than half. As I have discussed elsewhere, this creates major economic distortions for the US and the other anglophone economies, whose financial sectors benefit especially at the expense of their manufacturing sectors.

It is only because the US and, to a lesser extent, the anglophone economies, are willing to export unlimited claims on their domestic assets — in the form of stocks, bonds, factories, urban real estate, agricultural property, etc — that the surplus economies of the world are able to implement the mercantilist policies that systematically suppress domestic demand to subsidise their manufacturing competitiveness. This is precisely what John Maynard Keynes warned about, unsuccessfully, in 1944. He argued that a dollar standard would lead to a world in which surplus and deficit countries would adjust asymmetrically, as the former suppressed domestic demand and exported the resulting demand deficiency.

The point is that dollar dominance isn’t simply about choosing to denominate trading activities in dollars the way one might have chosen, in the 19th century, between gold-backed franc, gold-backed sterling, or Mexican silver pesos. It is about the role the US economy plays in absorbing global savings imbalances. This doesn’t mean, by the way, that the US must run permanent deficits, as many seem to believe. It just means that it must accommodate whatever imbalances the rest of the world creates.

In the fifty years characterised by the two world wars, for example, the US ran persistent surpluses as it exported savings. Because Europe and Asia at the time urgently needed foreign savings to help rebuild their war-torn economies, it was the huge US surpluses that put the dollar at the centre of the global trading system during that period.

By the 1960s and 1970s, however, Europe and Asia had largely rebuilt their economies and, rather than continue to absorb foreign savings, they wanted to absorb foreign demand to propel domestic growth further. Absorbing foreign demand means exporting domestic savings, and because of its huge domestic consumer markets and safe, profitable and liquid asset markets, the obvious choice was the US. Probably because of the exigencies of the cold war, Washington encouraged them to do so. Only later did this choice congeal into an economic ideology that saw unfettered capital flows as a way to strengthen the power of American finance.

This is why the end of dollar dominance doesn’t mean a global trading system that simply and non-disruptively shifts from denominating trade in dollars to denominating it in some other currency. It means instead the end of the current global trading system — Ie the end of the willingness and ability of the anglophone economies to absorb up to 70-80 per cent of global trade surpluses, the end of large, persistent trade and capital flow imbalances, and, above all, the end of mercantilist policies that allow surplus countries to become competitive at the expense of foreign manufacturers and domestic demand.

The end of dollar dominance would be a good thing for the global economy, and especially for the US economy (albeit not, perhaps, for US geopolitical power), but it can’t happen without a transformation of the structure of global trade, and it probably won’t happen until the US refuses to continue absorbing global imbalances as it has for the past several decades. However it happens, a world in which trade isn’t structured around the dollar will require a massive transformation of the structure of global trade — and for surplus countries like Brazil, Germany, Saudi Arabi, and China, this is likely to be a very disruptive transformation.