A Big Deal Going Forward
This week wasn’t exactly what HAI would call slow and uneventful. Quite the opposite! We learned that Donald J. Trump is on his way back to the White House after a blowout election victory. We also learned that Fed Chair Jay Powell and the FOMC cut the Fed funds rate by a further 25 basis points, despite still sticky core consumer price inflation that has remained well above the Fed’s 2% target for 41 consecutive months.
As to the Fed’s rate cut, HAI couldn’t sum up the expected news any better than ex-Bridgewater executive Bob Elliott did this week. At the August Jackson Hole summit, Powell said that the direction of travel for rates is clear (lower). As Bob Elliott described this week, the latest 25 basis point rate cut just looked like the Fed is “continuing down that path… data or prudence be damned.” As HAI has mentioned repeatedly, that “data or prudence be damned” aspect referred to by Elliott is likely the result of a Fed that, despite its official dual mandates, needs to cut rates because of compromised monetary policy resulting from excessive U.S. debt in a new era of fiscal dominance.
As to policy implications stemming from a second Trump presidency, HAI will leave that analysis to myriad others for now, but will have more to say on the topic in the coming weeks.
This week, HAI will focus on more subtle but important events likely to have fallen through the cracks in light of the flashier news. In particular, HAI will discuss a couple of extremely telling communications: a very revealing Inter-Agency Working Group (IAWG) report released by the Treasury Department titled Inter-Agency Working Group’s efforts on Treasury Market Resilience, and a standout clarifying interview with BlackRock’s Rick Rieder on Bloomberg.
In HAI‘s view, the IAWG Treasury Department report was a real eye-opener for anyone curious about the rapidly deteriorating U.S. fiscal problem and its link to the growing appeal for hard assets—specifically the growing demand for gold as the newly preferred global reserve asset.
The IAWG that compiled the Treasury Department report is representative of a broad cohort of U.S. government agencies. It was composed by staff from the U.S. Treasury, the Federal Reserve Board, the Federal Reserve Bank of New York, The SEC, and the CFTC.
In HAI‘s view, the inter-agency report is very strong evidence that, broadly speaking, the U.S. government knows it has an acute and accelerating fiscal problem that is negatively impacting both Treasury and Federal Reserve functioning. The report makes it clear that the ultimate result of this problem is that the Treasury is issuing increasingly more debt than there’s any domestic or international demand for. Further, the report makes clear that the waning demand is driven by large structural U.S. deficits as far as the eye can see, now compounded and complicated by surging interest expenses due to higher interest rates.
In HAI‘s view, the IAWG report highlights and underscores the developing bond market dilemma: in light of massive debt and deficits, a too-loose Fed policy will decrease demand and drive a sell-off in bonds because of reinvigorated inflation concerns, but so will a deficit-busting higher-for-longer policy. In short, policymakers can’t effectively pull their policy levers to maintain sufficient demand for U.S. debt. They’re damned if they do; damned if they don’t. It’s a new era.
First, in a section of the report titled “Large structural deficits leading to rapid Treasury market growth,” the IAWG adequately frames the problem. They point out that Treasury debt outstanding has ballooned by $11 trillion, or 66%, just since 2019. Furthermore, the IAWG highlights the Congressional Budget Office’s (CBO) own projection of nearly $2 trillion in annual deficits over the next five years, increasing to nearly $3 trillion by 2034—and that’s assuming no recessions or crises and a continuity of current law.
Next the IAWG acknowledges that the Committee for a Responsible Budget (CFRB) estimates that new policies could raise the national debt through 2035 by a further $3.5–$7.5 trillion over CBO baseline projections. Furthermore, the IAWG reveals the fiscal problem’s Achilles’ Heel and Powell’s particular pickle: higher interest rates following the post-pandemic inflation outbreak will result in interest outlays of over $1 trillion annually “going forward,” which will pose “substantial challenges to meaningful deficit reduction.”
Then the IAWG notes the inconvenient truth that while U.S. debt supply is booming, foreign buyers aren’t picking up the excess slack. Their report shows that foreign official holdings as a percent of total Treasurys outstanding has dropped in a steady downtrend from 38% post-GFC to 15% at present. Furthermore, the IAWG states that US Primary Dealers’ (banks that act as market makers) intermediation capacity has also not kept pace with issuance. In fact, the IAWG states that holding U.S. Treasurys “does not generally produce sufficient returns on capital…” As a result, “dealer balance sheets devoted to USTs have not come close to keeping pace with the growth of UST debt outstanding.”
There you have it—neat, tidy, and to the point: we have a real debt problem, and a lack of willing and obvious candidates to act as new buyers to absorb the excessive future debt issuance needed. No wonder gold is increasingly being substituted for Treasurys as the global reserve asset of choice.
John Dewey once wrote that, “a problem well stated is half solved.” Unfortunately, HAI is not certain the saying applies to our debt and deficit issue. Who is going to absorb the projected tsunami of ongoing excessive U.S. debt issuance?
In answer to that question, the best the IAWG could do was to propose a number of new unconventional policies and regulatory changes that would effectively supply additional dollar liquidity into the bond market to act as a volatility shock absorber. Importantly, the variety of proposals from the IAWG would all add additional U.S. dollar liquidity in a manner similar to quantitative easing (QE), but would do so without having to call it QE. In the end, however, the IAWG still anticipates that, in order to provide sufficient liquidity support for the bond market, the Fed will end its present quantitative tightening policy (reducing its balance sheet by selling Treasury debt it previously bought) by the middle of next year. The IAWG then expects the Fed to resume its balance sheet expansion operations again in the first quarter of 2026.
In HAI‘s view, what’s needed is a fundamentally healthy remedy to the debt and deficit problem, not more temporary extend-and-pretend policy measures aimed at scraping up more liquidity to support the bond market and absorb ongoing problematic levels of new debt issuance. In HAI‘s view, such measures may temporarily alleviate some of the supply/demand mismatches in the bond market, but they won’t stop the free market’s growing preference for gold over Treasury debt as the preferred global reserve asset.
In short, the IAWG report seemed to confirm the existence of a now-acknowledged debt problem, as well as the ongoing commitment to use increasingly impractical and unconventional measures to address it.
On Thursday, after the Fed FOMC meeting and Powell presser, we also got further evidence that even Wall Street may be growing increasingly weary of a U.S. debt and deficit extend-and-pretend game already long in the tooth.
Keep in mind that Wall Street is something of a well-oiled machine whose mantra frequently seems to be, “never let the truth get in the way of a good story.” In contrast, alternative finance at its best aims at distilling the truth above all else. After all, a good story is not always true, but the truth is always a good story.
Occasionally, however, a noted Wall Street insider will tell the same truthful “good story” as an alt-finance compatriot. In HAI‘s view, those instances are very notable markers that a mainstream consensus view is about to change. Said otherwise, those instances are often a good marker that an alternative minority view is about to become mainstream consensus.
This week, in an exchange on Bloomberg television that this author found far more crucial than the Fed meeting that preceded it, Rick Rieder, Managing Director and Global CIO of Fixed Income at mainstream Wall Street financial behemoth BlackRock, offered us one of those great big flashing markers that the mainstream consensus may be about to change. In short, on prime time TV, Rieder offered compelling evidence that the Wall Street narrative and Western investor consensus that U.S. debt and deficits don’t matter now appears to be very much on thin ice.
When HAI hears what sounds like non-consensus truth expressed by a mainstream BlackRock Managing Director, the expectation is not only for that truth to flow downstream toward becoming Wall Street consensus, but that it will ultimately take up residence in the collective mind of the Western investor—on a lag.
In HAI‘s view, Rick Rieder spoke truth this week, and this author took note. In addition to confirming that, yes, Houston, we have a debt problem, Rieder also confirmed that awareness of the problem is on the verge of becoming mainstream, as is the portfolio solution to the problem—scarce “real assets.”
Speaking to Jon Ferro, Lisa Abramowicz, and Tom Keene on a special edition of Bloomberg Surveillance following the Powell presser on Thursday, Rieder responded to a question about the recent rise in bond yields, despite Fed rate cuts, by saying:
“Listen, we’ve got to deal with the debt and deficits and what it means for currency going forward… More and more people are thinking about real assets… I think that’s playing through… I don’t do a client meeting today where the first or second question isn’t about the debt of the country and the deficits we’re running…There’s just too much debt coming due… We’re issuing so much debt every single week that every client wants to know [about the debt]…and I think it gets to that question of why are people buying real assets… But gosh, every client meeting I go to, people want to talk about the debt, and I think it is definitely going to become much, much more of a regular dialogue in everything we do… I think it’s going to be a big deal going forward…and it’s not just the debt—and we’ve never had this in the U.S.—it’s the debt service… It’s going to be a big focus.”
Rieder could not have been clearer: there is a rapidly growing acknowledgement of the acute nature of the U.S. debt problem, as well as interest expense problem (and by extension the monetary policy problem). According to him, the widespread acknowledgement of an acute problem is headed toward becoming consensus, and as the problem becomes “much more of a regular dialogue,” it’s going to be “a big deal going forward.”
In HAI‘s view, Rick Rieder just confirmed that, given the extraordinary circumstances, the hard asset/real asset thesis isn’t just a good story, it’s the truth. That truth, however, isn’t yet mainstream consensus. HAI‘s conviction is that as the thesis grows into consensus, the transition will unleash a reallocation of capital that will lift hard assets on a secular journey not to be missed.
As previously stated, HAI won’t overly elaborate this week on the possible implications of a second Trump presidency. That said, in an interview with Tucker Carlson this week, Robert F. Kennedy Jr. said he believed Trump would do “shocking” and “impolitic” things “in a good way” during his second term. Only time will tell, but one can certainly hope that some of those “shocking” and “impolitic” things “in a good way” will be focused on resolving the seemingly intractable U.S. debt and deficit problem and righting the wayward ship of state for the benefit of us all. One can only hope. Otherwise, as Rick Rieder warned, that debt and deficit problem is going to be “a big deal going forward.”
Weekly performance: The S&P 500 surged 4.66%. Gold dropped by 1.98%, silver was down 3.77%. Platinum was off 2.43%, and palladium was crushed by 10.52%. The HUI gold miners index lost 1.69%. The IFRA iShares US Infrastructure ETF surged 7.24%. Energy commodities were volatile and modestly up on the week. WTI crude oil gained 1.28%. Natural gas was nearly flat, up 0.23%. The CRB Commodity Index was up 0.80%. Copper was volatile and lower, down 1.50%. The Dow Jones US Specialty Real Estate Investment Trust Index gained 1.30%. The Vanguard Utilities ETF gained 1.56%. The dollar index was up 0.66% to close the week at 104.89. The yield on the 10-yr U.S. Treasury was off 9 bps to close at 4.31%.
Have a wonderful weekend!
Best Regards,
Morgan Lewis
Investment Strategist & Co-Portfolio Manager
MWM LLC
