While we lament the death of private debt markets every week, here is precisely what the Fed, the Treasury, and all bank CEOs are doing all their best to keep hidden until they are safely on their private jets heading toward warmer climes: in 2010, the total estimated net issuance across all US$ denominated fixed income classes is expected to increase by 27%, from $1.75 trillion to $2.22 trillion. The culprit: Treasury issuance to keep funding an impossible budget. And, yes, we use the term impossible in its most technical sense. As everyone who has taken First Grade math knows, there is no way that the ludicrous deficit spending the US has embarked on makes any sense at all… none. But the administration can sure pretend it does, until everything falls apart and blaming everyone else for its fiscal imprudence is no longer an option.
Out of the $2.55 trillion in expected 2010 issuance, $200 billion will be absorbed by the Fed while QE continues through March. Then the US is on its own: $2.35 trillion will have to find non-Fed originating demand. To sum up: $200 billion in 2009; $2.5 trillion in 2010.
Where’s the funding going to come from? Russia, China and Japan clearly no longer have the appetite and have been moving away from buying Treasuries. The smoke and mirrors game we discussed can only last for so long. The Fed only has three options and none of them are good. They can choose to not end QE and to continue it for the remainder of the year. However, this would not be very popular with voters and the politicians are dropping in the polls quickly. They can increase interest rates but that would destroy the housing market again and runaway inflation would follow quickly. Finally, they can engineer a drop in the stock market. As a result investors would quickly shift from Stocks back to Treasuries. To me this last option seems most like the decision makers DNA, which could mean potentially a 30% drop in the DOW. So be very careful. If a drop happens, it will be quick and hard.