Editor’s Note: Something very unusual is happening in the plumbing of the global financial system, and it has Wall Street spooked. That’s the message from Pete Carmasino, chief market strategist with Chaikin Analytics. As he shows, both U.S. Treasurys and the U.S. dollar are falling, something that normally doesn’t happen. Below, Pete explains why this is happening and what it means for markets… and everyday investors. Read on.
There’s a major driver of uncertainty in this market…
And it has to do with America’s global economic prowess. I’m talking about the fear that the U.S. dollar will lose its global “reserve currency” status.
Folks, let me be clear from the jump…
That isn’t going to happen.
Now, cynics will point to an anomaly in the markets right now. Both the prices of U.S. Treasury bonds and the value of the U.S. dollar have fallen together in recent months.
That doesn’t usually happen. Typically, one rises while the other falls. That’s because of the relationship between interest rates and the yield curve.
But a massive shift is happening right now. If you don’t understand it, you risk losing a lot of money. However, you can protect yourself if you see what’s really going on…
Wall Street Is Spooked About Falling Demand for U.S. Treasurys
First, think about it like this…
You likely have a checking account.
Money comes in from your job. And money goes out for groceries, gas, and other stuff.
If you spend more money than you bring in, you’re technically running a “deficit.” How do you pay for the difference?
You borrow. You use your credit card or take out a loan that you’ll pay for down the road.
The U.S. does the same thing…
For a long time, the U.S. has bought a lot more stuff from other countries (imports) than it has sold to them (exports). We make up the difference with “IOUs” – U.S. Treasury bonds.
This strategy worked fine for decades. Countries like China would sell us phones and TVs, get a big pile of U.S. dollars, and then use the dollars to buy U.S. Treasury bonds.
For China, it’s a bonus that everyone considers U.S. Treasury bonds the safest in the world. But beyond that, the Chinese government follows this strategy to protect its own currency.
China gets the best of both worlds. With this approach, it can own the world’s best bonds and not convert U.S. dollars to yuan.
In the meantime, the U.S. funds its operations on bond sales. So over the long run, it has been a good relationship. The overall system of inflows and outflows is tracked in the “balance of payments.”
Ultimately, everything coming in and going out just needs to balance. And for a long time, foreign countries willingly helped us support our spending deficit.
But that’s now changing…
Put simply, the trust that held this system together is being tested.
President Donald Trump and his administration want more balance today. By that, I don’t mean they’re looking to completely erase the trade deficit. They just want to reduce it.
New White House policies could lead to the U.S. buying less from the rest of the world.
That means fewer dollars are flowing out of the U.S. to countries like China. When these countries have fewer dollars coming in, they have fewer dollars to buy U.S. Treasury bonds.
So demand is falling. And that has Wall Street spooked.
But that’s not the only pressure that the bond market and the U.S. dollar are facing…
They’re Also Selling
You see, foreign countries aren’t just buying fewer new U.S. Treasury bonds. They’re also actively selling the bonds they already own.
For example, China has been slowly cutting back its holdings of our debt for years.
As of March, China’s pile of U.S. Treasury bonds had fallen to $765 billion. The country even dropped from the second-biggest to the third-biggest foreign holder of our debt.
Why would China sell?
Well, maybe the Chinese government is worried.
Perhaps China sees a government starting trade wars and piling up debt at a record pace. And in turn, maybe Chinese officials believe holding that government’s “IOUs” – U.S. Treasury bonds – doesn’t seem so safe anymore.
The move could be strategic, too. The U.S. is in an economic battle with China. So China could try to make things tougher by getting rid of U.S. Treasury bonds in droves.
What happens if a huge owner of something starts selling as fewer new buyers show up?
The price crashes.
That’s the key to understanding why the value of the U.S. dollar and the value of U.S. Treasury bonds have both fallen together recently. It’s a simple case of supply and demand…
When China sells a U.S. Treasury bond, it gets paid in U.S. dollars.
But the Chinese government can’t use U.S. dollars to pay their workers or build roads in their country. They need their own currency. So they sell those dollars on the open market.
That creates a flood of dollars. And when supply exceeds demand, its value goes down.
That’s why the U.S. dollar is weak right now. It’s not because of fears that the dollar will lose its reserve-currency status. (And even if it did, that would take years – not days.)
This last step is the most important one. When a massive player like a central bank sells huge amounts of U.S. dollars, it dramatically increases the supply of dollars in the market.
In this case, the “price” of the dollar is its exchange rate against other currencies. More dollars flooding into the market makes each dollar worth less.
The same thing is happening to U.S. Treasury bonds. Huge sellers like China are dumping them as fewer new buyers show up. So bond sellers need to cut prices to find buyers.
When bond prices fall, interest rates rise.
That means higher costs for the U.S. government to borrow. It could also mean higher rates for folks like you and me with our mortgages, car loans, and credit-card debt.
This isn’t a forecast for the U.S. government’s interest expense. It’s happening right now. And it’s causing a lot of people to worry about what might happen next.
However, it’s the normal course of business in the bond market.
Trust me, I’ve traded bonds for more than 20 years.
It’s worth knowing about this big cause of market uncertainty. I hope my explanation helps. And ultimately, my aim is to make sure you can protect yourself and your money.
Stay alert for more short-term uncertainty and volatility. The push and pull of the bond market isn’t always pretty.
But in the end, we’ll all be fine.
Good investing,
Pete Carmasino
Chief Market Strategist, Chaikin Analytics
Editor’s Note: If the markets have you on edge, we’d encourage you to hear from Chaikin Analytics founder, Marc Chaikin,
next Wednesday. On that day, Marc is sounding the alarm and unveiling what he calls the biggest breakthrough of his 50-year career. Beginning July 7, he believes a rare kind of investment vehicle – found in less than 3% of public companies – could hand investors the chance to double or triple their money, even in a choppy or declining market. In our experience, when Marc Chaikin has a big prediction, it pays to listen. Get all the details right here.
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