A specter is haunting the markets – the specter of a US$4 trillion Treasury funding requirement for 2021. The Fed is now the last buyer standing in the world’s biggest fixed-income market, buying virtually all of the massive issuance of federal debt, as we noted in our March 1 Chart of the Day.

The deficit hasn’t been this big since World War II, but there’s a difference. The American public financed the deficit of the 1940s with Liberty Bonds. Now the Federal Reserve is financing it on its own balance sheet.

Foreigners, who took up a great deal of Treasury debt during and after the Global Financial Crisis of 2008-2009, have stopped buying Treasuries. China, the largest official holder of US government bonds, isn’t motivated to bail America out at the moment.

Japan, the largest incremental buyer, is out of the market. Private investors don’t want to own US bonds because it’s dicey to hedge the currency risk. That problem erupted last March, as Asia Times reported at the time, and foreigners have shunned the Treasury market since. The falling dollar hasn’t helped matters.

With the Fed acting not only as the buyer of last resort but the only big buyer, liquidity is vanishing in the Treasury market, and that’s dangerous. The Fed needs another buyer and US banks are the only significant buyer of Treasuries beside the Fed. They need a steeper yield curve to make money in Treasuries, by borrowing short and lending somewhat longer term.

As the Chart of the Day shows, banks buy more Treasuries when the yield curve steepens. If we divide the data into high-growth (before the pandemic) and low growth (after the pandemic) intervals, we see that the relationship is extremely close.

That probably explains Federal Reserve chairman Jerome Powell’s desultory promise of support for the Treasury market at an online seminar Thursday. Market participants had expected a full-throated promise of support at any price but Powell only said that he was watching the markets and was a bit concerned about disorderly conduct.

Treasuries promptly sold off and the curve steepened. Stocks once again got hammered.

The Chinese commentariat is watching with interest. “With the special status of the US dollar as a world currency, the United States never has to worry about the repayment of national debt, because it can be repaid by expanding the issuance of US dollars,” wrote a commentator at the Observer (guancha.cn) last week.

“But can the United States continue to issue bonds to stimulate the economy and increase wealth. Can it last forever? In other words, can the US debt grow without limits?…US debt expansion is unsustainable, and it is destined to face the ceiling of the market,” the Observer commentator wrote.