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The U.S. Doesn’t Have Nearly Enough Debt

Robert Burgess
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The U.S. Doesn’t Have Nearly Enough Debt

(Bloomberg Opinion) -- Bond traders are either very afraid or very reckless. Despite a collapsing U.S. economy and a federal budget deficit that’s forecast by the Congressional Budget Office to triple to $3.7 trillion this fiscal year, the government is having no trouble borrowing. That was evident in the $190 billion — $190 BILLION! — of Treasury bills and notes the government sold on Monday.

Each of the four separate auctions met with above-average demand. The star of the day was the auction of $42 billion of two-year notes. Investors bid for 3.1 times the amount offered, the highest so-called bid-to-cover ratio since January 2018. There’s no question that the U.S. fiscal situation has deteriorated, and will likely only get worse. Besides that bulging budget deficit, the U.S. has seen its total debt outstanding jump to almost $24 trillion from less than $10 trillion during the financial crisis. And that’s before accounting for the trillions of dollars the government will need to borrow to finance its economic rescue packages. Of course, there’s always a chance that a surge in supply will overwhelm demand, sending borrowing costs soaring and leading to major losses for bondholders. But that’s been a concern since time immemorial when it comes to the U.S. debt markets. It’s why the bond vigilantes have gone extinct. The better way to interpret the auction results is that despite the recovery in stocks in recent weeks, investors are worried that there will be a long, slow and painful recovery marked by the greater threat of deflation than inflation. After all, why else would anyone agree to lend money to the U.S. government for five years at an interest rate of just 0.394%?

This may be evidence that Modern Monetary Theory isn’t so crazy. In essence, it suggests that countries with their own central banks — like the U.S. — need not worry about budget deficits and borrowing because those central banks could just buy whatever debt the government issues. Although the Federal Reserve isn’t buying debt directly from the government, it is buying bonds on the open market, pushing its balance sheet assets up by almost $2.5 trillion to $6.57 trillion since the end of February.

HERE WE GO AGAIN?A week ago, the price of a barrel of oil fell below zero for the first time, with West Texas Intermediate crude futures tumbling all the way to negative $40.32. That was largely due to traders fleeing the May futures contract ahead of its expiration so as not to get stuck actually holding physical barrels of oil with no place to store it. Prices rebounded when the futures contracts rolled over the next day, but they have since reversed course, falling as much as 30% Monday to as low as $11.88 a barrel. Some traders say it’s possible that oil slips below zero again soon rather than later. This time, the moves appeared to be tied to the largest oil exchange-traded fund. More specifically, the United States Oil Fund LP said it will move all the money it invested in the front-month June WTI oil contract starting today, triggering a massive swing in the price relationship between the June and July contracts, according to Bloomberg News. This all may sound technical, but the moves are rooted in fundamentals. The simple fact is, the sudden stop in the global economy came at a time when there was already too much oil sloshing around the world with no place to store it. And like with the bond traders scooping up Treasuries at miniscule rates, the evidence that nobody wants to own oil futures maturing soon and risk having to take physical delivery of crude shows that the oil market doesn’t see economic demand picking up anytime soon.

BUT WHAT ABOUT STOCKS?The S&P 500 Index rose on Monday to close at its highest level since March 10, bringing its gains since March 23 to 28.7% even though the Covid-19 infection rate continues to rise and economists keep downgrading their forecasts. To be sure, this is hardly a clear sign that stocks are expressing optimism about the future. In a research note sent to clients, Larry Hatheway and Alexander Friedman, partners in the newly formed Jackson Hole Economics, note that behind the headlines about surging equity markets, investors are being highly selective, shunning the most economically sensitive sectors, countries, and financial instruments. “There is a rush into safe, reliable companies that are likely to fare relatively well in uncertain and risky times,” they wrote in the report. Their research shows that the market’s gains are largely due to five companies: Microsoft Corp., Apple Inc., Amazon.com Inc., Google-parent Alphabet Inc. and Facebook Inc. These companies account for more than 20% of the S&P 500 in terms of market value, a record high.  Just a few years ago, the five largest stocks in the S&P 500 accounted for around 11% of the benchmark. It just so happens that these companies are “widely regarded as the winners in a world where lockdowns have forced everyone online,” according to Hatheway and Friedman. So while a cursory glance at stocks may suggest an optimistic outlook, what it’s really saying is that social isolation, uncertainty, and economic peril will be around for a longer period than many may think.

BRAZIL ON THE BRINKA political crisis in Brazil is at risk of morphing into a currency crisis. The real weakened for a fifth straight day Monday, bringing its year-to-date decline to 29%, despite aggressive efforts by the central bank in recent days to stem the depreciation. Brazil is no ordinary emerging market. Its $2 trillion economy is big enough that a crisis there would have ripple effects around the world. The latest leg lower in the real came as highly regarded Justice Minister Sergio Moro, who gained famed for taking down a network of corrupt politicians and CEOs, resigned on Friday. President Jair Bolosnaro refuted Moro’s allegations that he had tried to interfere with federal police investigations. “The upshot here is at least four new risks on the horizon: 1) resignation of Economy Minister Paulo Guedes; 2) the start of impeachment proceedings; 3) diminished prospects of much needed economic/fiscal reforms; 4) risk of an even worse handling of the Covid-19 crisis,” the strategists at Brown Brothers Harriman wrote in a research note Monday. “It’s hard to make a favorable investment case for Brazilian assets beyond being oversold.” 

TEA LEAVESThe Conference Board’s measure of consumer confidence among Americans dropped in March by the most since August 2011, tumbling 12.6 points to 120, as the coronavirus pandemic took hold in the U.S. That plunge was likely just a harbinger of even worse news to come. The Conference Board’s April reading comes Tuesday, and the median estimate of economists surveyed by Bloomberg is for consumer confidence to fall off a cliff, declining 32 points to a reading of 88, the lowest since 2014. With some 20 million people out of work, it’s no surprise confidence is degrading at a rapid rate. The key for government and central bank officials, who have spent trillions of dollars supporting the economy and the financial system, is to make sure consumers have hope that conditions will improve. Otherwise, a lack of confidence risks becoming entrenched, delaying any economic recovery.

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This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Robert Burgess is the Executive Editor for Bloomberg Opinion. He is the former global Executive Editor in charge of financial markets for Bloomberg News. As managing editor, he led the company’s news coverage of credit markets during the global financial crisis.

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