It is possible that the US Fed will lower interest rates in September and follow through with more cuts in later months. The US government will benefit from these moves, because lower rates will help feed the voracious appetite for debt.
But just because the discount rate, the rate that applies to primary credit extended to US financial institutions goes down, does not mean bond yields, like the 10-year US bond rate, a key borrowing rate for the US, will go down. The discount rate is determined by the Fed, while the US 10-year treasury is determined by the market.
If demand for US 10-year treasuries goes down, the yield offered to lenders will have to go up. If investors are skeptical, they have to be incentivized through higher interest rates.
Thus, the key question is “going forward, how strong will demand be for US 10-year and other long dated Treasuries”? This is important to gauge because a US treasury buyer is lending the United States money, taking credit risk.
If trust or confidence towards the US declines, demand for US bonds will decline. Unfortunately, there are reasons why trust and confidence in the US may decline in the coming months.
First, President Trump firing the head of the BLS will diminish trust and confidence in US data, potentially harming demand for treasuries. Investors base their actions on models with multiple interconnected variables. Labor is one of the inputs. If investors cannot trust the labor input because it is politically manipulated, they may be hesitant to invest more money into US treasuries, lowering demand.
Second, there may be a decline in the US dollar reserve status. Reserve currencies are held by foreign countries to facilitate transactions, and reserves are used to buy treasuries. As of now, the US dollar is the main reserve currency at 59% of total global reserves. But there is growing talk of new reserve currencies coming into the picture like Renminbi or Euro.
Third, if the US Fed lowers interest rates without inflation under control, investors will demand more yield to make up for the loss of purchasing power stemming from inflation.
Fourth, the US is nearing its debt limit. Yes, Congress may bow to President Trump and raise the debt ceiling, but that is just kicking the can down the road. Everyone knows the US has a debt crisis that is getting worse. No one wants to be the last pillar of demand before things go bad.
Finally, there is speculation that the growth of US dollar stable coins will keep demand for US treasuries high. Blockchain issued stable coins must be backed 1:1 by US treasuries. If the demand for US dollar stable coins goes up, demand for treasuries will too. However, US dollar stable coins represent 98% of the total stable coin market. There will be other stable coins; it cannot be assumed the US will continue to represent 98% of stable coins over time. Thus, a lower market share may lead to less demand for US dollar stable coins, and the treasuries backing them.
Over the past year, the US 10-year bond yield has gone from 3.98% to a high of 4.79% to its present level of 4.25%. If demand for US bonds from foreign investors goes down, the US 10-year yield could stay around this level.
If the US 10 year stays around this level, the attractiveness of higher yielding bonds like Etherfuse’s Brazilian Tesouro and Mexican CETES will be enhanced. Selling USTRY and buying one of these bonds can create a great yield pick-up in a time of uncertain US bond demand.
This blog is for educational and informational purposes only, covering general market trends, industry developments, and asset features. Nothing herein is investment advice, a solicitation, or a recommendation to buy or sell any assets. Etherfuse and its guests may hold stakes in some or all of the assets discussed.
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