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Signs of Potential Turmoil in Global Financial System

Financial markets have been experiencing a period of relative calm since the turmoil caused by the failure of three significant US banks in March 2023, which required rescue operations by financial authorities. However, beneath the surface, signs of potential turmoil are beginning to emerge. These signs are centered around ongoing liquidity issues in the $26 trillion US Treasury market, currency divergences, and concerns about the increasing role of private credit in the financial system.

Last week, a tremor shook the Treasury market during a “shaky auction” for $44 billion worth of seven-year US Treasury notes. The shortage of buyers forced major banks, essential to the market’s operation as primary dealers, to purchase 17 percent of the debt, higher than usual. This followed subdued demand in auctions of two- and five-year debt, leading to lower debt prices and a rise in the interest rate on the 10-year bond.

The immediate cause of these issues is the realization that the Federal Reserve is unlikely to make significant interest rate cuts in the near future. With US government debt approaching almost 100 percent of GDP, concerns are growing about the sustainability of the country’s fiscal trajectory. Treasury officials and financial experts are wary of the potential consequences, recalling the market freeze in March 2020 when the US Treasury market experienced a crisis at the start of the pandemic.

In addition to the Treasury market concerns, currency markets are also showing signs of distress, with the US dollar strengthening against other currencies like the Japanese yen and the Chinese renminbi. The decline in Chinese holdings of US debt and the pressure on the renminbi raise questions about potential currency crises in the region.

Another area of concern is the growth of private credit funding, with warnings from industry leaders like Jamie Dimon about the risks involved. The emergence of risky products in the private credit market echoes the issues seen before the global financial crisis of 2008, raising fears of similar outcomes.

As these warning signs continue to mount, the global financial system faces potential instability that could have far-reaching consequences for economies worldwide. Vigilance and proactive measures may be necessary to prevent a crisis from unfolding.