Treasuries, Money Market Rules, and the US Debt Ceiling
By JC Collins
Though a final decision is expected on November 30th, there has been much speculation about why the International Monetary Fund decided to wait until next October to implement the effective date of the new SDR basket. The inclusion of the Chinese currency into the Special Drawing Right composition will serve to position the RMB as a reserve currency. This move is expected to increase international renminbi demand and decrease international demand for USD denominated securities.
In the post Renminbi Demand Is About to Explode I wrote the following:
“…there could be $500 billion in RMB reserve demand once the announcement is made. This accumulation of RMB denominated reserves will begin the process of mass diversification away from the USD denominated reserves.”
This shifting of reserve accumulation has created additional challenges for the United States in finding methods of funding its huge government budget deficits. The recent increase in the debt ceiling will take the US through another fiscal year, but the lower international demand for Treasuries will have to be offset with demand from elsewhere. But from where is the big question.
An answer can be found in the new money market rules which are set to come into effect on Oct 14, 2016, right around the time when the new SDR basket composition will be implemented. These rules were designed to address the concerns of regulators about how money market funds contributed to the financial crisis of 2008.
For simplicity sake, the changes will require all money market funds, excluding US government money market funds (Treasuries), to enact new rules which will prohibit investors from making withdrawals during periods of volatility. This measure will force a money market migration from Prime funds to government money funds as investors seek to avoid the new measures.
Interested readers can learn more about these new money market rules here.
It is expected that between now and next October there will be as much as $650 billion which will shift into short-maturity government obligations (Treasuries). This increase amounts to a revolution in the US government money market sector as tens of billions which have flowed into government money market funds will now become hundreds of billions.
The amount which is being associated to the increase of RMB demand is non-coincidently similar to the amount which is being attributed to the increases in the US government money market sector.
Financial lobbyists have succeeded in delaying the implementation of the new rules until next October, which is also the timeline which they have lobbied for the effective date of the new SDR composition. The fact that both dates align with the schedule of US government budgets and debt ceiling debates should not be considered a fluke.
In the post Renminbi Demand Is About to Explode, I also stated the following:
“This depreciation of the USD will correspond with the beginning of monetary policy normalization. The likelihood of the Fed increasing interest rates in December is improving. As I’ve stated continuously, this is exactly what the US wants. Domestic jobs will increase with the increase of American exports. In turn, the debt-to-GDP ratio comes down and America will be able to look at more sustainable fiscal budgets in the years to come.”
“Trump and his mantra of making America great again falls exactly in line with the multilateral monetary transition which I have been describing for almost two years now. On top of what I’ve already stated, Trump is now coming out saying that Janet Yellen has not raised interest rates because Obama told her not too. Apparently Obama doesn’t want to see the bubble burst under his watch.”
“But like the political pressure is building for a stronger renminbi, there is an equal amount of pressure building for an increase in interest rates. Policy normalization is being promoting by everyone from the BIS, IMF, to regional and central banks. Even the emerging markets themselves are starting to get on the rate increase bandwagon and stating that the Fed should just get on with it.”
“The unwinding of this debt bubble, and USD reserves, will cause some initial volatility and not all corporations and investment vehicles will survive the transition. The availability of a strong dollar alternative will mean that capital flows from the USD to the RMB will take place.”
The potential of a Fed rate increase on December 16th will set the stage for the next phase of the multilateral monetary transition. The workaround for the 2010 Quota and Governance Reforms should be implemented around the same time. The correlation with this and the money market changes will coalesce into a clear and concise pattern of fiscal transformation which the next US administration can claim and harness for political power.
The mystery as to why the effective date of the new SDR basket composition was delayed is reasonably solved. It is not an exaggeration to state that this is the most important SDR change since its inception. The overall effect this transition will have on the US dollar, and the international monetary system as a whole, cannot be overstated. – JC