Naturally, it was Stan Druckenmiller's comments about bitcoin that garnered most of the immediate attention after our show yesterday. "The significance of the world's greatest and most respected money manager...saying he is long bitcoin cannot be overstated. That has removed every obstacle for any hedge fund or endowment to invest," tweeted macro strategist Raoul Pal.
But I thought Druckenmiller's warnings about the dollar and Treasury markets were much more intriguing. Recall this is someone who made his career shorting the British pound with George Soros, so his bearishness on the greenback is not to be taken lightly.
And this isn't a dollar-crash-is-coming! kind of alarmist call, either. Druckenmiller more sees it headed on a three-to-five year slide lower, and that's actually supportive of the stock market and anything else priced in dollars, like gold, copper, and yes, bitcoin. Still, his points about why this is happening set off plenty of alarm bells to me.
It goes back to the Covid crisis in March. Stocks were in freefall, dropping 40% in a month. Usually, in a crisis, Treasury yields collapse, too, as investors pile into the safest asset class in the world. "Flight to safety" and all that. But the week before the market bottomed, Treasury yields suddenly spiked. The benchmark 10-year yield surged from 0.65% to over 1.2% in two days. The catalyst? The $2.2 trillion CARES Act.
"It was something I had never seen before," Druckenmiller said yesterday. "The bond market [tanking] while we were in a risk-off meltdown." The sellers, he said, were foreigners--typically the biggest buyers of U.S. debt. Instead, they sold $1 trillion of U.S. bonds in 48 hours, he said, hastening the Fed's need to come into the market and start buying $500 billion of Treasuries a week.
Why were foreign investors so spooked by the CARES Act? Because (a), its price tag, said Druckemiller, meant the U.S. deficit rose more in the six weeks after its passage than in the five previous recessions combined; and (b), most of the aid was simple transfer payments from the government, in contrast with China's response which also included incentives for infrastructure projects.
And foreigners, who own more than a quarter of our debt, have been net sellers of U.S. Treasuries ever since, said Druckenmiller. The dollar has held up better so far than expected in part because foreigners have at the same time been large buyers of U.S. equities, particularly the big-cap "stay at home" technology plays. Ironically, Pfizer's vaccine news yesterday could unwind that support, as foreigners reinvest in their home markets amid expectations of a global recovery.
So what happens to the bond market now? That could be up to the Fed. The central bank bought more Treasuries in the three months after that March yield spike than in all the QE over the previous decade, Druckenmiller said. During all the "quantitative easing" of the Bernanke and Yellen regimes, the Fed never bought more than $70 billion of Treasuries a month--and they're still buying about $120 billion a month today.
It's a question that came up at the Fed meeting last week and that we'll likely hear more of after the vaccine news--why isn't the Fed dialing back its support? This, I think, helps give the answer. The Fed, according to Druckenmiller, has bought more than half (57%) of all new Treasuries issued since March. "Instead of having the Fed buy alongside foreigners," he said, "now we have them selling to the Fed. In other words, the Fed has been monetizing the debt."
Now imagine if Congress had passed the original $3.4 trillion HEROES Act in May on top of all that. Today, we get plenty of Fedspeak, from the likes of Rosengren, Brainard, Bostic, and Kaplan. "They cannot with a straight face say QE will continue at $120 billion a month for years to come since the ONLY reason why they are...doing so is because of this virus," wrote analyst Peter Boockvar this morning. "Hopefully they'll get asked, because the Pfizer news changes everything."
The Fed, in other words, at some point may have to straight-out say that it's buying so much U.S. debt because it has to in order to keep yields from spiking, instead of "because the economy needs it." (And this is even as the Fed has been pushing Congress to do more.) If they don't think yields would spike without their support, because other large buyers would step in, they should say so.
Given that the 10-year yield nearly hit 1% yesterday, markets are likely already starting to test just how high yields can now go. We're at quite an inflection point.
See you at 1 p.m!