Big loss for the US Treasury

On June 27^th the US Treasury Department announced the resignation of a top agency official; Jeffrey Goldstein, he will leave the domestic finance department at the end of July. He was overseeing the Dodd-Frank Act implementation and the chief architect of the Financial Stability Oversight Council. The reason released by the Treasury of his leave is because he wants to spend more time with his family, which is the yardstick reason many US government officials are given to resign. Goldstein, was a managing director of the World Bank and was a key person for the government’s involvement with Fannie Mae and Freddie Mac. Before he took the position of US Treasury official two years ago he had to pay at least $10.5 million to several investment partnerships according to his ethics filing. This doesn’t show a boast of confidence in the implementation and strategy for Dodd-Frank Act and the future of the US Treasury given a top official has left in such short time frame.

http://www.reuters.com/article/2011/06/28/usa-treasury-goldstein-idUSN1E75Q1ZG20110628

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aD6yvvScHUPM

Who's buying Treasuries?

Back on March 18^th 2011 I posted a chart showing that Bill Gross one of the largest bond managers of Pimco, has been dumping his Treasury holdings. This new chart shows that QE2 has been mainly funded (63%) by our very own Federal Reserve through their POMO program (see the 2^nd chart). So essentially the majority of the U.S. budget deficit is funded by central banks and with a sub 3% 10-year note who knows who else would buy bonds with the AFP reporting that the U.S. is already defaulting on their debt: http://ca.news.yahoo.com/china-ratings-house-says-us-defaulting-report-054309883.html

It seems from the 10-year breaking the 3% level that the treasury market might be pricing in some type of support for a QE3. I guess time will tell...

What would QE3 mean for the markets?

With QE2 ending next month there is an expectation that the Fed’s balance sheet will come to a standstill at approximately $2.75 Trillion. Given the rise in the money supply and banks increasing their lending throughout QE2 the rapid expansion experienced during those months could place pressure on continue lending by banks and generate expansionary economic activity because of the decrease in the money supply. Some economists are torn between a continued QE program on the face of inflationary pressure or unemployment prospectus. The first argument has the CPI (Consumer Price Index) heading towards the lower levels of 5%, while the second item of unemployment is expected to remain 8.7% for 2011 according to the latest (May 13^th) Bloomberg survey. Whichever item provides the strongest pressure if QE3 were to be implemented (And I personally think it will) the unveiling would occur before the January 2012 presidential election kickoff season. The pressure on the Treasury market after June could fold either way but there is enough buyers both institutional and foreigners to drive the market up and keep yields low. But many factors could come into play such as China’s growth, the IMF’s (International Monetary Fund) leadership change, and the Eurozone debt crisis plus that the number 3 has been notoriously famous in government such as the 3 branches of powers (Legislative, Executive, and Judicial).

Charts from: http://mises.org/daily/5299/The-Effects-of-Freezing-the-Balance-Sheet

The US yells Bingo as the debt limit is reached.

In an announcement made early today Monday May 16, 2011, the US Treasury has stated it has reached the $14.294 Trillion debt ceiling. As a result of this recent motions the Treasury department plans to stop issuing and reinvesting in government securities into certain pension plans. These and other measures would delay the default of the US government until August 2^nd. However, Vice President Joe Biden is holding negotiations with lawmakers with some of the deficit-cutting measures that are being requested to win approval to negotiate a higher debt limit. Some of speculators are saying some of the cuts are going to be made to agriculture subsidies and federal retirement programs, anti-fraud efforts, and increased premiums for pension plans by the Pension Benefit Guaranty Corporation and the sale of wireless spectrum and government properties.

http://online.wsj.com/article/SB10001424052748703421204576325583050561022.html?mod=WSJ_hp_LEFTTopStories

When the US has reached its debt limit

As the national debt continues to increase by an average of $4.05 billion per day since September 28, 2007 even in 2009 the Obama administration noted that the deficit for fiscal year 2009 came in at a record of $1.42 trillion with a capital “T”. This was in 2009 but now the story has turned more severe as Timmy Geithner stated that the legal limit of $14.3 trillion would be reached within a few weeks from now (as of the end of April).

Although the political cards begin to play into whether to lift the debt limit, the Treasury secretary has a few options available such as borrowing money from the federal workers pension plan or paying investors their interest payments ahead of their obligations. Regardless, if the limit gets a raise the ramifications would mean higher interest rates for consumers since the bond yields will rise as investors lose more confidence in US treasuries. This stressful situation has occurred many times in the history of the US as the debt ceiling was raised six times between 1995 and 2007 but never has it been such a wide spread media publication. As the political big wigs debate on whether constricting further spending or cutting outlays while raising taxes the ones feeling the strain would be the US consumers as the cost of borrowing will eventually rise and perhaps at a frightful pace. As a final and last attempt by the US Treasury they have setup a site where the general public can donate:

https://www.pay.gov/paygov/forms/formInstance.html?nc=1271991815942&agencyFormId=23779454

Article: http://www.garp.org/news-and-publications/overview/story.aspx?newsId=27689

Why so low 3 and 6 month Treasury

The effects of the Dodd-Frank Act are beginning to have repercussions in the Treasuries market as U.S. banks began to hoard Treasury bonds thus putting a strain on the repo market. This strain was present on Friday April 8^th and Monday April 11 when the 6-month T-Bill touched an all time record low yield of 11 bps and the 3-month T-Bill touched a 13-month low yield of 3 bps.

This Treasury desert amounted to about $40 billion on Friday raising the anxiety level for future higher borrowing costs for money market funds and their respective investors. The rule was implemented by the FDIC on April 1^st and forced many large banks to refrain from lending out their Treasury Holdings thus eliminating bank arbitrage opportunities thanks to the plentiful Treasury bond supply constraint collateral from the Fed’s $600 billion bond buying program.

Before April 1^st banks would typically lend out their Treasury holdings in the overnight Treasury repo market and take those proceeds and leave them at the Fed which paid them some interest on the reserves. Some large banks would also borrow funds from GSE’s such as Fannie Mae or Freddie Mac in the Fed-Funds market and park them in the Fed to earn a little higher spread. Although, these unintended consequences seem to be short term while markets become accustom to the rule, this past week’s yield lows had some effects in profitability for large money market funds around the world.

http://www.reuters.com/article/2011/04/05/markets-money-idUSN0512901520110405

The FOMC likes firm foots in their minutes.

At the March 15^th FOMC meeting stated that the recovery is gaining strength and they plan to adhere to their $75 Billion in Long-Term Treasury bonds each month through June 2011. The chart below shows the Fed’s balance sheet composition over the past four years and although the minutes mention a tapering effect taking place in the purchase of Treasury securities the obvious effect is shown by the treasury yield curve steepening.

Although the Fed officials admit in continuing downside risk in the US housing market and the ramifications of the European fiscal adjustments their chosen word for economic growth is their belief in a “firmer footing.” The committee also expects economic conditions including low rates of resource utilization, subdued inflation trends and stable inflation expectations, to warrant exceptionally low levels for the federal funds rate for an extended period.

My concern is when the Fed planes their exist strategy, how do they plan to tackle the obvious inflation and unemployment situation. Just remember that even when the US was in an obvious recession back in Feb 2008 Uncle Ben stated that he doesn’t foresee any recession and that it’s simply a correction in the markets.

http://www.federalreserve.gov/newsevents/press/monetary/fomcminutes20110315.pdf