In case you missed it in our last post, here’s an interesting chart illustrating how the U.S. budget deficit has been funded since 2010 on a quarterly basis. The data are annualized.
During QE2 and QE3, from Q4 2010 to Q4 2014, the Federal Reserve indirectly financed 60 percent of the deficit on an average quarterly basis. Add to that foreign financing, mainly central banks, and the budget deficit was indirectly overfunded, freeing up capital for other risk assets, and for bond prices to move higher.
We just calculated foreign purchases of Treasury securities from the TIC data in Q4 2017 at a negative $12.7 billion. The market is waking up, though not yet internalized, to the fact the easy money to finance growing U.S. budget deficits has gone away. Also, the Fed and foreign central banks were not price sensitive and motivated in their purchases of Treasury securities by policy concerns.
Recall Greenspan’s bond market conundrum, where the Fed lost control of the yield curve during the housing and credit bubble as foreign central banks were recycling excess dollars back into the U.S. bond market. Greenspan lays the blame for the genesis of the housing and credit crisis on this very fact and not ultra-loose monetary policy.
The U.S. government will now have to scramble to finance trillion dollar deficits as far as the eye can see with price-sensitive capital. Unless foreign central banks start showing up again, the U.S. financial markets will have a trillion dollar hole to fill each year, unprecedented in this new century.
Real interest rates have only one direction to travel. North.