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Fiscal risks will take center stage after debt ceiling, and Treasury could cause a ‘breakage' - Lyn Alden
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(Kitco News) - While all the attention has been going to the debt ceiling and the Fed’s interest rate decisions, the real story will be what happens afterwards and how the Treasury manages to replenish their reserves, according to Lyn Alden, Founder of Lyn Alden Strategy.
“I think that there's maybe too much market focus on what Powell is going to do, and not enough focus on what's going to happen in the fiscal environment,” Alden said. “What I am focused on is what happens after the debt ceiling.”
Alden spoke with Michelle Makori, Lead Anchor and Editor-in-Chief at Kitco News at Bitcoin Miami earlier this month. She said recent comments by Jerome Powell, who said that the Fed might not need to be as aggressive with its rate hikes because the banking crisis contributed to tightened credit, can be interpreted more than one way.
“I think there's two sides of it,” she said. “I think what he's saying is correct, it's not just about rates, it's also about the rate of money creation, and if banks are liquidity-constrained, if they're risk-off, they're less likely to make loans and that actually slows the economy.”
Alden said, however, that there’s also an unspoken subtext to Powell’s remarks. “Because of how quickly they raised rates and how much damage they did to the banking system […] they've created this financial instability, and now they're in a situation where they have trouble raising rates as quickly as they have been, even if they wanted to, without causing more issues. I think that they're both trying to justify why they're going to slow down their rate hikes, and then just be setting expectations around the fact that they can't really do it.”
As for what the Fed might do at the next meeting, Alden said they may now have the credibility to pause, and she thinks that’s the most likely scenario.
“They don't want to surprise markets, so I think if they were going to raise rates they would start hinting at it ahead of time,” she said. “I think right now they're going to be more data-dependent, and they're going to try to balance between financial stability and inflation, whereas the past year they've been 100% focused on inflation. I think the last hike they did made sense because they still wanted to preserve their credibility, they wanted to have the view that they're not stopping because of the banks, but now that they got that hike in, now they have more flexibility from a public perception standpoint to pause if they want to.”
“We'll see if they take that approach, but I think they probably will.”
Banks are more stable, but fragile
Alden also said the banks appear to have stabilized, and the current environment “looks more like a profitability challenge than a liquidity challenge” but the situation remains fragile. “I think the risk for banks now is that they probably are going to have to reduce share buybacks, slow or pause dividend growth, and try to build capital, that's kind of the base case,” she said. “But if the Fed gets aggressive again or if there's some sort of unexpected catalyst, I don't think we're out of the woods yet for risks of further liquidity crisis. I wouldn't say I'm confident that the banking system is settled, even though I think maybe the rate of change, the speed of some of this is behind us.”
Risks now on the fiscal front
One of those catalysts could come in the wake of the debt ceiling resolution, which was passed by the House on Wednesday and the Senate on Thursday, and will be signed by President Biden in short order.
“I think there's so much focus on the debt ceiling itself, there's not enough focus on what happens after the debt ceiling,” she said. “For the past six-plus months, the story has been Fed quantitative tightening, raising rates, but something that's not been covered enough is that the Treasury has actually been offsetting a lot of the Fed's tightening, the Treasury has been emptying their cash account into the financial system. Partly that was because they had too much cash in their account to begin with compared to their target, but then starting in January the debt ceiling actually made them lower their cash account.”
She said the Treasury's target is half a trillion dollars in the cash account, but in recent months they've drawn that down to under 100 billion because they needed to pay bills without issuing new debt. “Ironically, while that cash is draining out of this Treasury void and back into the financial system, it's actually offsetting a lot of the QT that's been happening,” she said. “They're nullifying each other.”
Alden said once the debt ceiling is fully resolved, if the Fed wants to continue with quantitative tightening while the Treasury wants to refill the cash account back up to the target, it could create a “double negative for liquidity” as both pull money from the market simultaneously.
“I think that's where you could get breakage,” she said. “If things surprise to the upside in terms of how bad they get, I think it would be because the Treasury does not manage that refilling process well.”
To hear Alden’s views on Bitcoin adoption, de-dollarization and gold, watch the above video.
