Moves by the US Treasury in the bond and currency markets amount to ‘soft-form financial repression‘ aimed at holding down long-term borrowing costs, Deutsche Bank’s head of FX research has warned, as CNBC reports that Treasury Secretary Scott Bessent has built the Treasury General Account to around $950 billion.
What the US Treasury soft financial repression moves involve
Bessent surprised Wall Street with a plan to increase buybacks of long-term bonds after the 30-year yield hit its highest level in nearly 20 years.
Weeks earlier, the US and Japan intervened jointly in currency markets to boost the yen, the first such joint action in three decades. To fund the move, the US sold euros rather than dollar-denominated assets, deliberately avoiding a sale of Treasury securities that would push yields higher.
Japan, the world’s largest holder of US debt, also refrained from selling Treasuries. Instead it used an obscure Federal Reserve tool, the Foreign and International Monetary Authorities Repo Facility (FIMA), which allowed it to borrow dollars against its Treasury stockpile.
George Saravelos, head of FX research at Deutsche Bank, said: ‘We see both the buyback and encouragement to use the FIMA facility for FX reserves as soft-form financial repression policies aimed at containing the long-end of the US yield curve.’
Dollar bears the cost, Saravelos says
Financial repression refers broadly to policies that keep interest rates artificially low by influencing financial markets. The US and other developed economies used it to cut their debt-to-GDP ratios after World War II.
A survey of 300 years of US and UK history found that wars are ‘always disaster times’ for holders of government debt because of inflation and financial repression, the report notes. Currencies suffer too.
Saravelos warned the suppression of Treasury yields would simply shift the burden onto the dollar. ‘If the market price of USTs is not “allowed” to adjust down, the foreign exchange price of UST owned by foreign investors has to adjust via a weakening in the dollar,’ he said.
He added that if Federal Reserve chairman Kevin Warsh ‘does not recognise the buyback as a factor driving an easing of financial conditions, we would take it as an additional dollar negative driver.’
Warsh has so far refrained from so-called forward guidance, leaving markets uncertain about his next move. The Fed has been wary of inflation, which has exceeded its 2% target for more than five years, with several central bankers prepared to raise rates.
Debasement trade gains momentum
Since the debt buyback was unveiled, markets have ramped up bets on the ‘debasement trade’, with gold and bitcoin prices rising on expectations of further dollar devaluation.
US debt stands at $40 trillion. The federal budget deficit is on track to hit $2 trillion this fiscal year, and debt interest costs alone are already $1 trillion annually, consuming an expanding share of government spending.
Saravelos said markets would grow ‘increasingly attentive to further measures intended to support the US Treasury market going forward. The more these are perceived as distortionary to market pricing, the more the dollar is likely to weaken.’
There is no sign Washington is moving to cut the budget or raise taxes. In that context, further financial repression looks the more probable path to managing borrowing costs.
A research paper from the International Monetary Fund said the world is primed for another wave of the practice. ‘With the conditions historically associated with elevated repression present today, our evidence suggests that financial repression may see increased use going forward,’ it said.
