Fed lures banks to buy unwanted US Treasuries

A specter is haunting the markets – the specter of a US$4 trillion Treasury funding requirement for 2021. The Fed is now the last buyer standing in the world’s biggest fixed-income market, buying virtually all of the massive issuance of federal debt, as we noted in our March 1 Chart of the Day.

The deficit hasn’t been this big since World War II, but there’s a difference. The American public financed the deficit of the 1940s with Liberty Bonds. Now the Federal Reserve is financing it on its own balance sheet.

Foreigners, who took up a great deal of Treasury debt during and after the Global Financial Crisis of 2008-2009, have stopped buying Treasuries. China, the largest official holder of US government bonds, isn’t motivated to bail America out at the moment.

Japan, the largest incremental buyer, is out of the market. Private investors don’t want to own US bonds because it’s dicey to hedge the currency risk. That problem erupted last March, as Asia Times reported at the time, and foreigners have shunned the Treasury market since. The falling dollar hasn’t helped matters.

With the Fed acting not only as the buyer of last resort but the only big buyer, liquidity is vanishing in the Treasury market, and that’s dangerous. The Fed needs another buyer and US banks are the only significant buyer of Treasuries beside the Fed. They need a steeper yield curve to make money in Treasuries, by borrowing short and lending somewhat longer term.