How Will 20-Year Treasury Bonds Impact the Economy?

20-Year Treasury BondsAccording to a Jan. 16 press release from the U.S. Department of the Treasury, within the first six months of 2020, the federal department will begin issuing a 20-year Treasury bond. This is the U.S. government’s attempt to maintain and support the federal government’s ability to borrow into the future. This action will also have an impact on the markets going forward, especially when it comes to the Federal Reserve and its monetary policy.  

The Federal Reserve’s many purposes include promoting stability and growth in the economy by keeping prices stable and healthy employment levels. The ways The Fed does this is by influencing short-term interest rates, being active in Open Market Operations (OMO) and impacting reserve requirements.

The Federal Reserve Bank of St. Louis details that along with providing banks with loans from the federal funds market to support adequate reserves and liquidity, it’s important to understand how Open Market Operations function.

Much like individuals and institutions can buy or sell securities, The Fed can buy or sell securities, including U.S. Treasury bonds. The buying and selling are the operations portion. The open market refers to the fact that The Fed doesn’t transact directly with the U.S. Treasury, but works on the open market via auctions through the Trading Desk of the New York Fed.

Assuming there’s a modification to the federal funds rate’s target range by the Federal Open Market Committee (FOMC), the directive starts the reaction to either purchase or sell government securities to meet the new target. The OMO is one way the Fed adjusts its two-pronged mandate of promoting employment and maintaining target inflation.       

If the Fed wants to stimulate the economy, it can do so through Treasury bond purchases. This occurs when the Fed makes a deposit into the seller’s bank account via the Trading Desk. This purchase increases the reserve balance of the bank offering the Treasury bond for sale, which increases the bank’s ability and willingness to lend.

In the opposite scenario, the Fed can reduce the amount of money available that banks can use for lending. This time the Fed sells government securities, prompting banks to remove money from their bank accounts, reducing the amount available for lending. As pressure on the federal funds rate increases, rates will go up, making loans cost more for borrowers and incentivizing savings.

During the financial crisis, the FOMC engaged in quantitative easing (QE) after it brought the federal funds rate to near zero. This approach consisted of buying longer-term U.S. Treasury securities and mortgage-backed securities (MBS) through open market operations. As the St. Louis Fed explains, in exchange for the Fed buying these securities, banks receive a credit that increases their reserve balances above reserve requirements. While this was far more prevalent during the financial crisis, the 20-year U.S. Treasury bonds will undoubtedly make QE easier to re-engage in.

While the government may benefit from the direct investment and its ability for the Fed to guide the economy, there are a few potential risks for those who invest in U.S. Treasury bonds. Compared to many other investments, Treasury bonds have lower yields, which are even lower when inflation runs high. Another risk is that when rates rise, the value of the Treasury bond goes down, creating less attractive debt if the owner wants to sell it.

The Jan. 16 press release noted that more details on the 20-year bond will be available in the U.S. Treasury’s quarterly refunding statement on Feb. 5. Only time will tell the level of interest among investors and how effective this instrument will be in creating further cash flow for the U.S. Treasury.

What Would a Phase One Deal with China Encompass?

The so-called phase one of a trade deal with China is expected to contain a provision for $40 billion to $50 billion in purchases of American agricultural products by China, according to an October news release from U.S. Sen. John Hoeven (D-ND) With ongoing discussions surrounding the US-Sino trade talks, there are rumors for such a partial trade deal. But how has the recent past impacted both countries’ economies and a mutual desire for better trade deals?

While not directly related but announced during a similar time frame, a November press release from the United States Trade Representative (USTR) announced Chinese acknowledgment and acceptance of American poultry exports. This stated that China will now accept $1 billion in American poultry and related poultry products, effectively reversing China’s ban.

After a December 2014 avian influenza outbreak, China banned US poultry in January 2015. America exported more than half a billion dollars of poultry to China in 2013, and there has been much interest in restarting exports to China since August 2017. With the USTR citing U.S. poultry exports of $4.3 billion in 2018, this will undoubtedly ensure America maintains its position as the globe’s second biggest poultry exporter.

According to a late October press release from the USTR, there will be a 30-day comment period in November to garner public opinion on continuing tariff exemptions on certain Chinese goods, worth approximately $34 billion. The items currently exempt are set to reverse exclusion on Dec. 28. Additionally, as part of phase one discussions, the United States is expected to not implement tariffs scheduled to take effect on Dec. 15, along with rolling back existing tariffs in stages.

Trade War’s Impact

According to BNP Paribas Wealth Management, the trade impasse between the United States and China has had a measurable negative impact on the world’s economy. BNP cited a 1.2 percent point reduction in growth over the past 1.5 years.

However, the phase one deal is expected to include many provisions, such as $40 billion to $50 billion of US farm product exports to China, along with $16 billion to $20 billion of Boeing aircraft for commercial use to China.

Financial institutions outside of China will be able to establish insurance companies in mainland China, financed by ex-China investments, along with being able to hold shares in the newly created entities. Ex-China lending institutions will be able to create wholly owned banks and conduct business in the Yuan or Renminbi (RMB) currency throughout mainland China without explicit approval from Chinese officials.

These developments, according to the Chinese State Council and China Banking and Regulatory Commission and CNBC, are part of the ongoing discussions to determine how China will increase IP protection and the aforementioned agricultural purchases. Announced on Oct. 11, 2019, the China Securities Regulatory Commission will work on lifting limits on ownership ceilings for ex-China entities, specifically in mutual funds, securities and futures operating in China.

BNP also mentions expectations of Dec. 15, 2019, tariffs to not be implemented, along with expectations for existing tariffs to be relaxed or reduced. In addition to giving American farmers increased sales, this will provide China with more soybeans for domestic consumption, including an ability to help increase the number of the country’s pork livestock population through feedstock. If phase one is agreed to, it’s also expected to help the RMB appreciate. Based on recent data, the RMB has appreciated by three percent since September 2019.   

One noteworthy item that depends on a phase one deal being certified is the expectation that it will positively impact the global economy. The International Monetary Fund dropped its World Economic Outlook gross domestic product projection from 3.2 percent in July 2019, down to 3.0 percent, based on the current trade tensions.

Since there’s great hope for a phase one deal that will encourage mutual and global economic development, there’s confidence that both countries facing economic hardships will find a short-term resolution.