The 10-year Treasury yield fell 10.7bps to 3.858% to close at its lowest since late December on 2 February, as fresh concerns about U.S. regional banks and higher-than-expected jobless claims prompted investors to turn to Treasuries, while the U.S. nonfarm productivity rose more than expected in the fourth quarter of last year, bringing unit labor costs under control, providing another boost to the Fed's anti-inflation action.
On 1 February, the Fed left interest rates unchanged at 5.25%-5.50% as expected and removed language that could raise interest rates further, but at the same time unexpectedly brought hawkishness to the market, officially showdown to the market, mercilessly shattering market expectations for a rate cut in March (see chart below for details).
The analysis shows that the core logic of the Fed's showdown is that it will cut interest rates but does not want the market to expect it too early, and at the same time, it also shows that the Fed is preparing and paving the way for interest rate cuts, but it does not want to be swayed by the market, so it is constantly pouring cold water on the expectation of interest rate cuts in March.
Immediately afterward, Fed Chair Jerome Powell said in a subsequent press conference that "a rate cut in March is not possible and is not the underlying case until there is more confidence that inflation will be lowered to target", "inflation has eased over the past year, but remains elevated", "the policy rate may be at the peak of this tightening cycle, and almost everyone in the committee believes that a rate cut is appropriate, but we have not considered when to cut rates, and there is a wide divergence of views on rate cuts".
This has led Goldman Sachs to postpone its expectations for the Fed's first rate cut from March to May, and expects five rate cuts this year instead of six, as for the path of interest rates in 2025, Goldman Sachs predicts three rate cuts, and CME Group's Federal Watch CME swap market expectations also show that the probability of a rate cut in March has dropped to about 35%, and about 140 basis points in 2024, which is 5 basis points less than before the rate decision.
In this regard, the "new debt king" Gundlach commented that we cannot expect the Fed to cut interest rates in the next three months, which all suggests that the US Treasury and companies are difficult to obtain low-cost funds.
At the same time, the latest interest rate meeting statement also removed the description of "the U.S. banking system is sound and resilient", whether this implies that the U.S. banking system is no longer sound and resilient, or the previous statement is lying, and the New York Community Bank, which took over last year's "thunderstorm bank", released a crash earnings report that shocked Wall Street's jaws, causing the stock price of the U.S. regional bank to plummet by 40%.
This suggests that the Fed's monetary policy of keeping interest rates high for longer will continue to pose a significant threat to the U.S. banking system, and that the New York community bank collapse may not be an isolated case, and may continue to contag other banks like the collapse of Silicon Valley Bank last year, exposing the vulnerability of the U.S. banking system to rapidly rising borrowing costs and increasing the likelihood of a widespread credit event, leaving Fed Chairman Jerome Powell, who is currently in a prisoner's dilemma.
It is clear that Powell is now holding a bottle of poison with still high inflation in his left hand, and a bottle in his right hand that keeping interest rates high for longer could overburden the US Treasury with financing and debt, and even more US bank failures like last year, suggesting that the trading logic of the US financial and bond markets is expected to change in the coming period.
The hidden logic behind this is that once there is a crisis in important sectors such as regional banks, the U.S. bond market and U.S. commercial real estate, the Federal Reserve will have to enter a state of bailout, especially the U.S. Treasury market, which is now in the midst of a storm and is full of questionable credibility, superimposed under the toxic cocktail combination of "high debt, high interest rates and low growth", and then counter the debt burden of the U.S. Treasury and detonate the nuclear bomb of U.S. financial debt ahead of schedule.
This comes at a time when there are only four months left before the "X date" when the US debt default is getting closer to running out of money, making a catastrophic US debt default a reality sooner rather than later, and the latest news and data are feeding back this trend.
Just after the Fed directly shattered the hope of a rate cut in March, U.S. stocks suffered the biggest one-day drop this year, the "new debt king" Gundlach said that Powell took away the "Goldilocks", the U.S. economic outlook seems to be more grim, a recession is still possible in 2024, and the unemployment rate will rise.
It is against this backdrop that on February 1, the U.S. Treasury Department increased the quarterly issuance of long-term bonds for the third time in a row, and will issue $121 billion in three-year, 10-year and 30-year bonds, which indicates that although the U.S. Treasury said that it will not increase the size of the U.S. bond auction until 2025 and lowered the size of the bond issuance in the first two quarters of this year on January 31, the intention of increasing the size of the long-term bond auction is obvious, reducing the U.S. Treasury to roll over more high-interest debt in a shorter period of time and reduce the pressure on interest payments.
In this regard, the U.S. financial website ZeroHedge analysis said that as of January 31, the U.S. Treasury has announced that it will issue a total of $1.05 trillion in new Treasury bonds, and the analysis shows that it may eventually need to issue a total of up to 2 trillion U.S. bonds in fiscal year 2024 to balance its spending and repayment of debt interest and related payments.
This is likely to continue to increase the size of the auction of notes and bonds, as evidenced by the fact that the Red Sea crisis has stimulated higher US inflation expectations and is likely to keep high interest rates for longer, as has already been the case in January, when US bond auctions exceeded expectations, which was the initial impetus for the sell-off in US bonds in the last two weeks.
According to a report published by Goldman Sachs analysts on February 1, it is estimated that if the U.S. federal debt reaches $39 trillion by the end of 2024 and is currently 34 trillion, it will mean a staggering 2 trillion in interest paid annually, and the latest debt projections released by the Congressional Budget Office on January 25 show that the U.S. federal debt and deficit burden will reach 189% of GDP in 2052, and the U.S. debt will reach $50 trillion, of which the debt interest cost will increase the fastest and then increase exponentially.
To make up for this massive deficit, the US authorities are likely to borrow more and more debt, making the debt mountain even bigger. At high interest rates, interest payments on the federal public debt soar and annual interest payments on US Treasury bonds will soon exceed $1 trillion, which could further exacerbate the deficit problem, plunging US finances into a vicious circle and a battle in Congress.
Such a large US debt raises the risk of eventually being unable to repay the debt and detonating the nuclear bomb of the US debt crisis, and may one day eventually lead to a default on US Treasuries and the collapse of the US dollar.
So, from this point of view alone, the Fed's late rate cuts and high interest rates will end up detonating the world's largest Ponzi debt nuclear bomb and bankrupting the US debt economy.
To add insult to injury, Moody's also analyzed in the report provided on February 1 that in addition to the surge in U.S. Treasury defaults, the default rate of U.S. non-financial companies in 2023 nearly tripled from the previous year, which made the spike in defaults in the 12 months last year affect about $91 billion in total defaulted debt, up from $38 billion in the previous year. Moody's expects the growth trend of U.S. institutional debt defaults to continue in 2024 and reach its highest level.
This is mainly because the Fed's aggressive interest rate hikes starting in 2022 have rapidly raised the burden on U.S. businesses to borrow and repay debt, and although the market expects the Fed to cut rates five times in 2024, according to the Fed's interest rate statement just now, this expectation may not be delivered.
This is a reminder to U.S. bond holders that the U.S. fiscal situation is becoming increasingly volatile, which could exacerbate concerns among everyone from asset managers to central banks around the world and others who hold large amounts of U.S. debt, with Dario, the founder of the world's largest hedge fund, warning in a Feb. 1 update that no matter how the U.S. Treasury sells U.S. Treasuries and what monetary policy the Fed takes, it is unlikely to solve the problems facing U.S. bonds in a substantive way.
So, from this perspective alone, the end result of the Fed's current slower rate cuts and longer pace of high interest rates will bankrupt the U.S. federal debt economy, which also means that the Fed will once again throw a financial nuclear bomb into the U.S. financial market, because high interest rates will eventually eat back into the U.S. financing market, which means that the U.S. ability to hedge debt interest with high inflation will be weakened, and the pressure on bond interest payments will increase rapidly.
This has deprived the U.S. Treasury of its ability to bail out its inflating debt and obtain low-cost financing, and at the same time, it has also weakened the Fed's ability to help the U.S. federal finance, making U.S. financing difficult, indicating that the Fed is throwing a financial nuclear bomb into the powder keg of U.S. debt, and the nuclear bomb that detonates U.S. finance may officially appear.
Recently, the withdrawal of a large number of billionaires from many cities in the United States, including Chicago, New York, Texas, etc., seems to be exposing the internal problems of the U.S. economy and the chance that the debt financial nuclear bomb will be detonated, which will become more clear in the environment where regional conflicts continue to escalate and may detonate U.S. inflation to rise again.
For example, public pensions in the United States have long been a financial timing nuclear bomb, and now it is getting closer to the fuse, which will officially unveil the fig leaf of the US debt economy, superimposed on the record debt of American cities, high interest rates, the cost of climate change, pension spending due to increased immigration and an aging population, and the current volatile environment in the United States are causing Wall Street traders to worry about the crisis in the US financial markets.
Immediately afterwards, the U.S. financial research institute zero hedging quoted the views of several traders on Wall Street to analyze that if the risk of implicit default of U.S. debt and the risk of technical default after the debt surge increases, and the high level of interest rates may detonate the financial nuclear bomb of U.S. debt, the world's central bank cornerstone buyers of U.S. Treasury bonds, including Japan, China, the United Kingdom and Belgium, are expected to reduce their holdings of U.S. bonds to the current 10%.
The U.S. media said that if uncertainty increases, some global central banks with billions of dollars in positions in the U.S. Treasury Department, including Australia, Vietnam, Iran, the United Arab Emirates, and Poland, have fallen out of the list of major U.S. bond holders, so as to reduce exposure risks.
Against this backdrop, U.S. Treasury Secretary Janet Yellen responded in an interview with the media on February 1 that "$34 trillion in U.S. debt is a terrible number" and that "we must take steps to ensure that the deficit is manageable," and reiterated that "U.S. Treasury remains the safest and most liquid asset in the world, and the dollar's position cannot be shaken."
She further said that "the U.S. debt financing dilemma is critical to prevent the Red Sea situation from escalating into a broader conflict in the Middle East, and the current high interest rates will bankrupt the country, and the resulting consequences for the U.S. financial system will cost us dearly, with debt service costs of more than $1.15 trillion over the next decade."
Just three days ago, U.S. Treasury Secretary Janet Yellen said at an event at the Economic Club of Chicago that the Republican Party's proposed debt ceiling funding cuts would be "destructive" and that the consequences for the U.S. financial system would be devastating," while repeating her trademark warning, acknowledging that "a default on debt would lead to a double catastrophe of economic and financial collapse in the United States, and would threaten all economic gains made since 2020."
This explains why the Fed is so stumped over when and how much to cut interest rates, and it's clear that the snowballing stability of US Treasuries and the stability of the US banking system are hampering the Fed's monetary policy. (ENDS)