The Treasury Department just said it plans to borrow a record $1.85 trillion in the second half of this year. And the Fed is selling off upward of $60 billion a month of its government debt holdings.

Who is going to buy it all?

Some think the Fed will have to reverse course and stop winding down its $8.2 trillion stock of government debt. Instead, it will have to go back to buying Treasury bills and bonds—a policy Wall Street calls “monetizing the debt.”

Or simply, “printing money.”

Caught between a rock and a hard place

The Treasury's appetite for debt isn’t the only headache for the Fed.

As another side effect of extreme borrowing, the coming glut of Treasury paper will probably cause bond prices to plummet. That, in turn, will drive interest rates much higher.

Normally, from the Fed’s perspective, that would be a good thing, because higher rates help bring down inflation.

But it increases the government’s borrowing costs at a time when it can least afford it.

Last year, the U.S. paid $724 billion in interest on its debt, up a full 26% from the previous year. With big borrowing increases planned for this year and next, its interest bill for 2024 could top $1 trillion.

As part of its anti-inflation policy (in financial lingo, quantitative tightening), the Fed has already sold $759 billion of its government debt holdings since the peak in April 2022.

Its share of the government’s $32.7 trillion in outstanding debt is now just above 15%—the lowest since 2014.

The Fed's ownership of federal debt

That seems like a healthy change, but it worries markets because of the Treasury’s recent announcement of its plans to boost its borrowing.

To avoid breaching the debt ceiling before it was increased in June, the government spent down its Treasury General Account: think of it as Uncle Sam’s “checking account.”

The Treasury now has to top it back up by borrowing—on top of all the deficit funding.

How much more debt is coming? The chart below shows the month-by-month changes. But the total figures are even more staggering. It is issuing more than $1.01 trillion in new debt this quarter, and $852 billion in Q4.

So how is the government going to get the market to mop up that $540 billion in government debt offloaded from the Fed, and the $1.85 trillion in new debt issued by the Treasury in the second half?

Basically, it will have to either pay much higher interest rates, or it will have to monetize the debt—if the Fed proves willing.

Shades of Japan

Fans of this strategy call it “yield curve control” (YCC).

In the simplest terms, YCC is a policy wherein the central bank commits to buy an unlimited number of bonds to fill the supply and “cap” their prices at the target level.

Japan has done this for years, but its problem is too little inflation, not too much. That’s on top of decades of lethargic economic growth and a mountain of debt that can’t spark it back up.

Of all developed economies, Japan is by far the most indebted with 255% debt to GPD—which is double that of the U.S.

Worse, once you start down that road, there’s no easy way out. And last week, Japan proved just that when the Bank of Japan (BOJ) essentially said it can’t stop printing money.

”We do not have an exit from monetary easing in mind,” BOJ deputy governor Shinichi Ichida said.

The reason? Policymakers can no longer wean the economy off cheap money.

The Fed’s moment of truth

If the coming blizzard of debt causes Treasury prices to crater and yields to rise so much that the government’s interest bill becomes unmanageable, the Fed will face a decisive moment.

It will have to demonstrate whether it really is what it claims it is—an independent guardian of the value of the dollar—or whether it is just a political shill acting at the behest of a profligate government.

If it continues to take economically painful moves to fight inflation, it will prove itself the former. But if it breaks step and begins printing money to facilitate the government’s debt binge, it will prove itself the latter.