Never Bark At The Big Dog. The Big Dog Is Always Right.
As another first for The Liberty Bullhorn, in our update last week on the Treasury interest rates we explained how on February 12 the 30-year bond had broken the two-percent mark for the first time since February 19, 2020. We noted that this happened while the rates on short-term bills were closing in on zero, and that the growing gap between the long-term and short-term rates suggests declining confidence among investors in the ability of the U.S. government to honor its debt obligations over the long term.
Today, we can report that this gap keeps growing, and that there is an emerging confidence fault line in the middle of the maturity dates for U.S. debt.
When sovereign-debt investors begin to doubt the fiscal solvency of a country, it is the very first step of many toward a situation where a partial debt default can no longer be ruled out. The United States is a long way from a default scenario, but as we explained in the latest issue of our Economic Newsletter, the ownership structure of the federal debt contributes to the worries related to the prospect of a future partial debt default.
Today we can report that the gap between long and short-term Treasury rates continues to grow. We are still the only economic-news outlet that reports on this, so stick with us (and get a newsletter subscription!) as we continue to update you on this situation. Figure 1 presents the average rates for long-term bonds with 10-30-year maturities (blue), and for short-term bills with 1-3 month maturity rates (red):
The widening of the bond-bill gap correlates with the inauguration of President Biden. It is reasonable to assume that investors have caught on to the attitude among Democrats in Congress and the Democrat president regarding budget deficits. In spite of having a Treasury Secretary who is relatively cautious on this matter, President Biden does not seem to inspire confidence in the long-term solvency of the government he has been elected to lead.
As yet more evidence on the flight from long-term to short-term debt, the seven-year Treasury rate is now at one percent for the first time since March 19 last year. Meanwhile, the one-year note fell below 0.1 percent right after the inauguration and has now reached 0.06 percent.
In other words, it appears to be the case that investors have grown lukewarm on U.S. debt with a maturity date of 1-5 years and have begun downsizing their holdings debt longer than five years. The growing demand for debt with a maturity date within one year suggests that they are not giving up on the federal government, but this shift is a clear warning sign to Congress to stop talking about more monetized debt and start talking about how to downsize the deficit.
We do not expect this gap to continue to grow for much longer. Once the Federal Reserve catches on to the emerging doubt in U.S. debt, it will take counter measures and intervene in the longer-debt end of the market. True to the principles of Quantitative Easing, they will soothe the market for now, but their operations will only exacerbate the doubt that investors have in the long-term solvency of the U.S. government. The fix, namely, will only address the symptom, not the problem itself which is the deficit monetization that Congress has gotten addicted to.
At this point – when the Federal Reserve intervenes to ease the rise in long-term rates – they will move us a big step closer to the systemic ailment of the euro zone. For an in-depth analysis of what that means, we recommend our Special Report on the European economy.