Jerome Powell’s bond market “conundrum” makes Alan Greenspan’s back in 2005 look quaint by comparison.
That was when then-Fed Chairman Greenspan was grappling with surprisingly low long-term bond yields despite his interest rate hikes. And despite concerns that government tax cuts might fuel inflation. Even so, U.S. borrowing costs edged lower, much to the Greenspan Fed’s chagrin.
Yet current Fed chief Powell faces something even more confounding. At a moment when U.S. debt is careening toward $30 trillion, President Joe Biden is having remarkable success in getting vaccinations in arms and inflation is the highest since 2009, yields on Treasury securities remain oddly low.
Rates on 10-year U.S. bonds are under 1.6%, compared with nearly 3% back in January. Many of the explanations why involve Asia, where central banks are particularly aggressive buyers of U.S. debt.
In a recent Institute of International Finance, chief economist Robin Brooks and his team hazard a few guesses. One, noisy data that have yet to show a convincing U.S. rebound. Two, the Fed’s still massive quantitative easing purchases. Three, steady foreign buying of dollar-denominated debt, especially by Asians.
Brooks thinks reason No. 1 is the dominant one. Yet it’s Asia that may decide whether the U.S. can avoid a world-shaking surge in debt yields. Washington’s main bankers are, after all, in Asia.
The top-10 Asian holders alone hold more than $3.5 trillion of U.S. government securities. Any whiff that, say, Japan or China is selling their dollar holdings would cause a financial earthquake.
Yet indications they are merely keeping holdings steady—not adding to their exposure—would greatly complicate life for Biden’s economic agenda.
Since passing a $1.9 trillion Covid-19 rescue package, Biden set his sights on a $2 billion infrastructure plan and a $6 trillion budget. When making such plans, Washington takes for granted that Asian central banks will gladly gobble up more U.S. debt.
That was George W. Bush’s assumption when he cut taxes in the early 2000s. It was Barack Obama’s assumption when he stimulated the economy, post-Lehman Brothers crisis, in 2009. It was Donald Trump’s assumption when he signed a huge 2017 tax cut financed via deficit spending.
In each of these episodes, America’s bankers showed up. Biden might face some skepticism thanks to the explosion of U.S. in recent years, but also fallout from Trump’s 2017 to 2020 policy chaos.
Trump had a very emerging-nation view of exchange rates. He ended the 23-year-old “strong dollar” policy and accused China, Japan and Europe early and often of undermining U.S. workers via exchange rates. He even broached the idea of canceling some portion of debt owed to Beijing.
The trade war, indiscriminate banning of mainland companies, the unhinged tweets, shocks to supply chains, broadsides against international institutions and excessive Fed easing all damaged faith in U.S. leadership. These Trumpian policies may be in the past, but what about in 2024? Trump is teasing a return to power, with all the economic chaos that might entail.
Biden needs to act fast to reassure America’s bankers that the U.S. Treasury and hopefully the Powell Fed have their back. That the time of erratic and capricious policy steps is over. And that America’s role in the Group of Seven will be less Trumpian spoiler and more adult in the room.
The U.S. must reassure Asia that the decades ahead will not be like the last one. In 2011, Standard & Poor’s yanked away Washington’s AAA rating, shaking world markets. That indignity came after Republicans played games with raising the “debt ceiling” so that the U.S. could honor its debt obligations.
The downgrade made then-Chinese premier, Wen Jiabao, seem clairvoyant. In 2009, he issued a rare public plea to the U.S. government to be more responsible about protecting the value of the more than $1 trillion of Treasury securities Beijing held (and still does).
As Wen said that then: “We have made a huge amount of loans to the United States. Of course, we are concerned about the safety of our assets. To be honest, I am a little bit worried.” He urged Washington “to honor its words, stay a credible nation and ensure the safety of Chinese assets.”
The Trump era has given Beijing exponentially more reasons to worry about the safety of Chinese state money. Though the explosion of Trump-era government debt preceded Covid-19, auction sizes since then have exceeded the direst predictions.
The Trump era has given today’s Chinese leaders Xi Jinping and Li Keqiang even greater reason to fret about the safety of Chinese state money. Even before the pandemic arrives, Trump administration spending was off the charts. Trump’s disastrous handling of Covid-19 has necessitated ever greater borrowing.
This leaves Biden with quite the balancing act: finding creative ways to stimulate growth without risking the wrath of credit rating companies or America’s most important financiers 7,000 miles away.
Pulling off this feat will fall to the Powell-Janet Yellen tag team. Powell, of course, replaced now-Treasury Secretary Yellen. The two have their work cut out to keep 10-year yields well under 2% and keep America’s Asian bankers calm. This region’s central banks have well over 3.5 trillion reasons to worry.