A Debt Ceiling Resolution is Not a Panacea. It Just Accelerates the End Game
It seems to me that the new global risk free rate is the Fed’s overnight RRP which is currently 5.05%. Nearly all global investors have some access to place money with the Fed overnight daily and can earn at 5.05% annualized.
While it is true that there remains massive excess liquidity in the financial system ($2.3trn in RRP), the cost of that capital is high enough now to make it rather sticky as investors don’t mind earning these rather high, safe yields in an increasingly challenging investing world. As a result, countries/companies/individuals are going to have to offer RRP investors more attractive risk adjusted rates of return for the capital to move. A rising global cost of capital world will see less money supply creation, a stronger $, slower growth and generally lower risk asset valuations over time in order to create risk adjusted return environments that get folks to move their capital out of the RRP.
The US Govt (post debt ceiling resolution) will be looking to raise capital in order to fund its burgeoning deficits and restock the TGA to give cover in case this political nonsense happens again. In order to raise that capital, they will have to compete with the RRP for access to that capital. We have already begun to see an acceleration in US govt borrowing costs in recent months as the Treasury has been forced to issue more bills at 5%+ annualized interest cost in order to fund recent auctions. Once the debt ceiling is cleared, and the Treasury begins to refill the TGA and issue duration securities again, there will be a massive amount of Treasury supply for sale that will need to pay higher and higher rates in order to get funded. As the US govt sees higher interest expense, its deficits will grow and more Treasury supply will be needed to fund any differences. Higher rates are also going to slow the economy and further slow down tax receipt growth, exacerbating the US BoP situation, necessitating even more UST issuance. This is a spiral that is not likely to stop. This US Govt borrowing is likely to crowd out any other global borrowers looking to gain access to capital (think regional banks, commercial real estate, VC, emerging market $ borrowers, etc).
At some point, the Fed will be forced to put more drastic limitations on the RRP usage or look to cut the rate on this free money in order to get this inert money to move. However, with the current US unemployment rate at 3.5% and inflation still running 5%+, there is simply no cover for them to do this yet. This inability for the Fed to act to lower borrowing costs will ultimately lead to significant dysfunction in the Treasury market and general financial market instability. This risk off trading is likely to eventually get the Fed to act as the Fed will be forced to succumb to fiscal dominance, will stop QT/enact QE/engage in YCC, and hopefully that will happen when they have already slayed inflation because if not, the hyperinflation in the US that comes on the other side of this, with a drastically weaker US$ vs hard assets/commodities is not going to be a world that many enjoy being in.
I remain been generally long gold and BTC while short US duration and equities to navigate this path.
The end game process has begun. Tread carefully.
Important Disclaimer: This blog is for educational purposes only. I am not a financial advisor and nothing I post is investment advice. The securities I discuss are considered highly risky so do your own due diligence.
