Though wage inflation came in nice and cool on Friday, the following chart illustrates why upward pressure on long-term interest rates will continue. We updated our Who’s Funding The U.S. Budget Deficit chart with the just released Flow of Funds data.
The Q4 2017 data show the Rest of World (ROW), primarily foreign central banks, and the Fed were net sellers of Treasury securities to the tune of $319 billion on a seasonally adjusted annual basis. This could be the reason why interest rates have spiked over the past three months. Note the Fed and other central banks have financed most of the U.S. budget deficit over the past ten years and foreign central banks were the largest financier of the Treasury leading up to the credit crisis. The main factor contributing to Greenspan’s bond market conundrum and what some believe the cause of the credit bubble.
We know with certainty, unless they reverse course, the Fed is going to be a big net seller over the next few years as they runoff their balance sheet. It is unclear as to what foreigners will do, but if they continue to reduce holdings or significantly cut back on their net Treasury purchases, real interest rates are heading north. Probably much quicker than the market expects.
Ironically, President Trump’s aversion toward trade deficits could lead to higher interest rates. If the administration succeeds in artificially suppressing the current account deficit by erecting trade barriers, foreign central banks will have less dollars to recycle back into the domestic Treasury bond market and may even become forced sellers. A potential train wreck in the making.
No more red and gold, and the reason why my Treasury position is sold.
How’s that for hip-hop?
Keep it on your radar.