US Treasurys Await French Lesson

UK Gilts Underwent Similar Experience

Last week’s SriKonomics focused on the benign response so far in gold, the dollar and US Treasurys to President-elect Donald Trump’s tariff threats. If the tariffs are actually imposed after the presidential inauguration on January 20 amidst a continuation of a large fiscal deficit, the note suggested, the outcome will be quite different, leading to higher Treasury and mortgage yields.

Developments in French financial markets over the past several days are a case in point for what could transpire in US bond markets in 2025. The French government led by minority Prime Minister Michel Barnier was brought down Wednesday by the joint decision by the far-right and leftist parties not to go along with a deficit-reducing budget that Barnier had introduced. Political uncertainty is expected to continue with the next legislative elections not to occur before July 2025 according to the French constitution. Left unchecked, France’s fiscal deficit is forecast to exceed 6% of gross domestic product this year compared with the European Union-established “safe” maximum threshold of 3%.

Reflecting elevated French sovereign risk stemming from the political instability, the yield spread between French and German 10-year obligations has been hovering at around 90 basis points, the most since the Eurozone crisis of 2012. (Germany is Europe’s benchmark for “risk-free” yield.)

Just as informative, 10-year French Treasurys traded at 2.87% yesterday, about the same level as corresponding Greek obligations. Recall that Greece was in financial crisis just 14 years ago and, at one point, had threatened to fall out of the Eurozone. France’s sovereign yield changes mirrored the pattern of UK gilts and mortgage-backed bonds when UK yields surged in October 2022 bringing to an end the short-lived Prime Ministership of Liz Truss. Truss’s government had introduced fiscal giveaways despite an unmanageable deficit.

Like France, the US fiscal deficit is also in the neighborhood of 6% of GDP with gross debt about 120% of GDP. Clearly, the United States has an advantage over France and the United Kingdom in that the dollar is a global currency in a way the euro and the UK pound sterling are not. If global traders do not want to accept the US dollar for transactions, they do not have another viable alternative — i.e., another currency that would have similar acceptability, or a currency market that is as vast.

Here the historical experience of the pound sterling is illustrative.

The pound was the leading global currency at the beginning of the 20th century. It was also the world’s oldest currency in continuous use. Shifts in global trading patterns led the Bank of England to abandon the gold standard in 1931, and the downfall of the pound’s dominance was very much in motion. Economic pressures on the United Kingdom arising from the Second World War further damaged the pound, and the currency became a distant second in global importance to the surging US dollar.

In short, currency seignorage for an issuing country — the privilege of issuing paper IOUs and exchanging them for valuable goods and services — is neither a given nor permanent. And that seignorage is an important benefit because it allows the issuing country to go through long periods of trade deficits without having to depreciate its currency. Finally, that privilege means that US sovereign debt is sought after globally, enabling Uncle Sam to borrow at lower rates than otherwise. But abuse the privilege, and the country becomes more susceptible over time to changes in global trade patterns, and domestic growth prospects get affected by international developments.

This takes us to Trump’s demand on Truth Social last Saturday that the BRICS countries (Brazil, Russia, India, China and South Africa) not form a currency of their own, competing with the US dollar. Should they go ahead with creating a common currency, the US President-elect said, he would impose a 100% tariff on products of those countries, effectively shutting them out of US markets.

It is extremely unlikely that a BRICS currency will come into existence — only Russia and Brazil favor its creation, China is cautious and India is opposed. However, imposition of such tariffs will result in higher Treasury yields and a stronger dollar, the obverse of the weaker BRICS currencies due to the countries’ exports being effectively blocked from US markets.

If the Trump administration wishes to maintain dollar supremacy over the long-term, the best way to achieve the objective would be to implement disciplined measures in exercising the United States’ key currency status. Bringing the fiscal deficit back from the elevated level it rose to over the past four years would be an essential step in maintaining global monetary primacy.

Finally, the new President will have a chance to maintain the dollar’s dominance through an opportunity that will present itself 16 months after he takes office. Jerome Powell’s term as Chairman of the Federal Reserve will end in May 2026. Filling the position with an individual who would replace the current seat-of-the-pants policy making with rules-based measures would increase confidence in US monetary policy and cement the dollar’s global status for decades to come.

Dr. Komal Sri-Kumar

President, Sri-Kumar Global Strategies, Inc.

Santa Monica, California

srikumar@srikumarglobal.com

@SriKGlobal

December 7, 2024

Sri-Kumar Global Strategies, Inc. advises multinational investors and sovereign wealth funds on global risk and opportunities. Dr. Sri-Kumar is regularly featured on business TV and Radio media, and is a frequent speaker in global financial centers on major topics that affect markets and investments.

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