An Incoming Tsunami: The US Treasury, Wall Street, and the Bond Market Unpreparedness Time Bomb
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Brace for impact, ladies and gentlemen!
The financial juggernaut that is the US Treasury is all set to unleash an unmitigated tsunami of bonds onto the unsuspecting markets. With Wall Street trembling and sounding alarms about market unreadiness, we find ourselves on the precipice of a dramatic financial fallout.
In the wake of the recent debt ceiling deal, the Treasury is gearing up for an unprecedented deluge of new bonds. This isn’t just a gentle wave; we’re staring down a torrent that threatens to drain our already dwindling liquidity. Picture this: bank deposits being raided and Wall Street panicking as the market trembles with unreadiness. The echo of the impending impact could easily dwarf any fallout from previous standoffs over the debt limit.
The Federal Reserve, with its quantitative tightening program, has whittled away at bank reserves, further compounding the situation. This one-two punch of quantitative tightening and a flood of new bonds threatens to severely undermine market stability. Money managers, smelling the scent of a recession, have already started hoarding cash, creating a financial siege mentality.
Renowned JPMorgan Chase & Co. strategist, Nikolaos Panigirtzoglou, a veritable oracle of market trends, estimates that this bond tsunami could knock a staggering 5% off the combined performance of stocks and bonds this year. On the other hand, Citigroup Inc. macro strategists are predicting a chilling 5.4% median drop in the S&P 500 over two months following this liquidity drawdown.
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As Monday approaches, the countdown begins for these bond sales that threaten to bulldoze every asset class, shrinking the money supply further. JPMorgan has estimated a broad measure of liquidity to fall by a whopping $1.1 trillion from about $25 trillion at the start of 2023.
Does this sound like a big liquidity drain? Panigirtzoglou thinks so too. According to him,
“We have rarely seen something like that. It’s only in severe crashes like the Lehman crisis where you see something like that contraction.”
The US, that political battlefield, has been relying on extraordinary measures to fund itself amidst the relentless bickering in Washington. Now, with the default narrowly averted, the Treasury is set to kick off a borrowing spree, reaching a staggering $1 trillion by the end of the third quarter.
Yet, what will ensue as these billions meander through our financial system remains an enigma. Banks, money-market funds, non-banks, including households, pension funds, and corporate treasuries, are all potential buyers of these short-term Treasury bills. But let’s not be fooled. The current yields on offer are unlikely to whet the appetite of banks who are comparing these to their own reserve returns.
Even if banks opt to sit out the Treasury auctions, their clients’ shift out of deposits and into Treasuries could wreak financial havoc. Citigroup has modelled historical episodes where bank reserves fell by $500 billion in the span of 12 weeks to get a sense of what may happen in the upcoming months.
The picture isn’t pretty.
We’re at a pivotal moment, one in which we’re teetering on the brink of a financial precipice. As the Treasury’s bond tsunami prepares to hit, the landscape of our financial system may change forever. We’re looking at the potential for stock crashes, credit spread widening, and riskier assets bearing the brunt of the losses. If you’re holding onto the S&P 500, Citigroup’s Willer has some chilling advice for you: “It’s not a good time.”
Now, more than ever, we need to brace for impact. The financial tsunami is on the horizon, and as it stands, we’re alarmingly unprepared. Prepare your lifeboats, folks; the storm is coming. The floodgates of the US Treasury are set to burst, and the aftermath promises to be nothing short of cataclysmic.
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