The Treasury Market is the Fed’s Next Crisis

The Fed’s next crisis is already brewing. Unlike 2008, where “subprime mortgages” froze counter-party trading in the credit markets as Lehman Brothers failed, in 2022, it might just be the $27 Trillion Treasury market.

When historians review 2022, many will remember it as a year when nothing worked. Such is far different than what people thought would be the case.

Throughout the year, surging interest rates, the Russian invasion of Ukraine, soaring energy costs, inflation running at the highest levels in 40 years, and the extraction of liquidity from stocks and bonds whipsawed markets violently. Since 1980, bonds have been the defacto hedge against risk. However, in 2022, bonds have suffered the worst drawdown in over 100 years, with a 60/40 stock and bond portfolio returning a horrifying -34.4%

Treasury Market, The Treasury Market Is The Fed’s Next Crisis

The drawdown in bonds is the most important. The credit market is the “lifeblood” of the economy. Today, more than ever, the functioning of the economy requires ever-increasing levels of debt. From corporations issuing debt for stock buybacks to operations to consumers leveraging up to sustain their standard of living. The Government requires continuing debt issuance to fund spending programs as it requires the entirety of tax revenue to pay for social welfare and interest on the debt.

Treasury Market, The Treasury Market Is The Fed’s Next Crisis

For a better perspective, it currently requires more than $70 Trillion in debt to sustain the economy. Before 1982, the economy grew faster than the debt.

Treasury Market, The Treasury Market Is The Fed’s Next Crisis

Debt issuance is not a problem as long as interest rates remain low enough to sustain consumption and there is a “buyer” for the debt.