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Health Check of the US Debt Markets

Just finished a read of the fresh new "Minutes of the Meeting of the Treasury Borrowing Advisory Committee".

The TBAC is a "meeting of the minds" amongst top U.S. officials dealing with borrowing and lending in America. Government, municipal, corporate and individual. The group includes government secretaries, Department of Treasury officials and Federal Reserve folks.

Yesterday they all met to health-check the state of debt markets in the U.S. Some very interesting points emerged.

First, the death of the U.S. government bond market is greatly exaggerated.

In the wake of the financial crisis, many analysts expected large government debts in America to scare away bond buyers. Not so.

In fact, buying (and particularly buying from Americans) is stronger than ever. U.S. banks have doubled their holdings of Treasuries over the past 2 years. Banks can't find trustworthy people to lend to, so they would rather stash cash in ultra-safe government bonds. Many institutions are also holding Treasuries to ensure they have some "back up" in the event of another crash.

And it's not just banks. The Committee also noted that pension funds and even mutual funds have been more active in the Treasuries market. (Americans bought $140 billion worth of Treasuries in June alone.) So much so that demand for even long-dated bonds is exceeding supply.

This flies in the face of conventional wisdom. Many observers believe that the expanding U.S. monetary base means inflation. But the majority of new money created in America has been given to banks. And those banks are plowing the cash right back into government bonds.

Money is not escaping "onto the street" where it can inflate things. Instead, it is moldering in bank vaults. Exactly what happened in Japan in the 1990s. And we know how inflationary that turned out to be.

One more small but critical note from the meeting. The Federal Reserve holds 27% of long-dated agency mortgage-backed securities (i.e., Fannie Mae and Freddie Mac).

The Fed is the only thing keeping the MBS market together. Over the last year, they've has purchased a Herculean $1.1 trillion in mortgage securities.

Mortgage backed Securities

This suggests a few things. First, something is still horribly wrong in the U.S. mortgage market. If the Fed needs to buy 27% of MBS in order to keep things functioning, there's a problem.

Secondly, there's a big hammer hanging over this sector. How will the Fed exit a position of this size without crushing prices? The government tried selling MBS to the private sector, and no one came. Now they own the market, and therefore they are the market.

By. Dave Forest of Notela Resources




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