The market is losing its appetite to fund US twin deficits – Deutsche Bank

George Saravelos is Global Head of FX Research at
Deutsche Bank is out with a striking note today, highlighting the problems with the US dollar, deficits and government policy. The note certainly resonates with US 30-year yields touching off 5% today.

He highlights the emerging consensus around the fiscal budget bill that’s working its way though Congress and the growing likelihood of higher deficits. That’s working against the White House’s stated aim of lowering the trade deficit because it gooses consumer demand.

They see the current account deficit continuing to rise.

“The significance of
this conclusion cannot be over-estimated. We have been arguing over the last
few months that the market is reducing its willingness to fund US twin deficits,” Saravelos writes. “We worry this is
brewing a major problem for the dollar and potentially the US bond market too.”

Adding to the vulnerability is a backdrop of larger foreign ownership of US assets and “extreme” valuation of dollar-denominated assets.

It’s tough to call a tipping point in this relationship but at some point the US will face a reckoning.

“For foreigners to
continue financing US debt one thing needs to happen: the non-dollar price of
US Treasuries needs to decline, either via currency depreciation or a drop in
the price of the bonds. The problem for the latter is that it makes US debt
dynamics even worse so is not sustainable. We are ultimately left with the only
solution to this problem being dollar weakness.”

Saravelos believes this is already unfolding as inflows to the US are slowing and that there is an emerging breakdown in the dynamic between USD/JPY and yields.

To sum it all up, as Secretary Bessent alluded to
himself, the US cannot be asking of the rest of the world to reduce its
imbalance with America if the US is not willing to reduce its own. The risk is
the rest of the world forces the correction upon the US in a disorderly way.

This article was written by Adam Button at www.forexlive.com.