(Bloomberg) – The barrage of new Treasuries set to hit the market over the next few months is just a prelude to what’s yet to come: a wave of longer-term debt selling set to drive further up bond yields.
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Sales of banknotes and government bonds are expected to start rising in August, with net new issuance estimated at more than $1 trillion in 2023 and nearly double next year to fund a growing deficit. The Treasury is already in the midst of an estimated $1 trillion increase in bills as it seeks to replenish its coffers following the debt limitation agreement.
It’s an explosive mix for borrowing costs as debt sales surge and the Federal Reserve continues to shrink its balance sheet at a time when traditional buyers of Treasuries overseas are discouraged by the costs of currency hedging.
“A deterioration in the fiscal profile, amid fairly modest spending cuts, suggests that the coming deluge of supply will not be limited to Treasuries,” wrote Anshul Pradhan, head of US rates strategy at Barclays Plc. . “The Treasury will soon have to significantly increase the size of the auctions across the curve. We think the rates market is too complacent.
Barclays strategists predict that the net increase in coupon debt from August to the end of the year will be nearly $600 billion. And that would only increase in 2024, they say, with an annual figure of $1.7 trillion. This would be almost double the expected debt issuance this year.
Pradhan says he doesn’t think the market appreciates the increased issuance that will be needed because of large budget deficits and the fact that the Treasury won’t want bonds to become a substantial part of total debt.
Total net sales of new bonds are expected to take their share of US debt to around 20%, according to JPMorgan Chase & Co. The issuance would reach a threshold considered by the Advisory Committee on Treasury Borrowing as the upper limit for the United States. United to finance deficits at the lowest possible cost to taxpayers.
Bank of America Corp. says the deluge of supply could lead to a “vacuum of demand” for longer-dated bonds, which could push yields higher and tighten financial conditions.
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Another pressure point is the fact that demand from traditional buyers like US banks and foreign accounts has declined.
For JPMorgan, this will likely force the Treasury to rely on “more price-sensitive buyers” like hedge funds and asset managers. That could mean “a higher term premium, tighter swap spreads and a steeper yield curve,” said Jay Barry, head of US government bond strategy at the bank.
The term premium is the additional compensation demanded by investors for holding longer-term Treasury bills rather than rolling over short-term bonds. It was positive until it fell below zero in the post-financial crisis era as the role of the Fed in the market increased. The 10-year term premium is currently around -0.88 percentage points, according to a New York Fed model.
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Meghan Swiber, rates strategist at BofA, says the combination of additional supply and still-positive US growth is problematic.
This “creates more question marks as to who the buyer base is, especially if there’s no recession,” Swiber said. “The biggest threat to this coupon supply being absorbed smoothly is a soft landing in the economy or the Fed adding further rate hikes.”
The US central bank remains determined to bring high inflation under control, and although June saw a pause in its interest rate hikes, officials expect further hikes by the end of the year. The Fed is also tightening its policy by reducing its bond portfolio by $95 billion a month, including $60 billion in Treasuries.
And given the strength of the U.S. currency, global investors face much higher costs to hedge against the risk of dollar exposure from buying Treasuries and, for the first time in decades, benefit from attractive rates on local debt securities.
“Currency hedging won’t work at the moment because hedging costs are expensive,” said Hideo Shimomura, senior portfolio manager at Fivestar Asset Management Co. in Tokyo. “Almost nobody does that in Japan.”
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Amy Xie Patrick, a Sydney-based fund manager who helps oversee the Pendal Dynamic Income Trust, adds that “there are sufficiently attractive rates closer to you that you don’t have to worry about whether you have a currency risk.
Ahead of the coming debt deluge, Treasury yields across the curve remain below their recent highs, but have trended higher since their lows in March when bank failures sparked a wave request for refuge.
Two-year Treasury yields are just below 5% and the global benchmark 10-year yield is hovering around 3.72% – well below last year’s high of more than 4% – but heavily discounted relative to short maturities because the curve is inverted.
U.S. bond yields are capped for now amid slowing growth and slowing inflation from its peak, but debt time is turning, said Jim Cielinski, global head of income securities. fixed at Janus Henderson Investors.
“It’s a slow burn,” Cielinski said. Additionally, “the interest rate bill is going to be much higher over the next three years. And the global savings glut is shrinking as the supply of debt increases.
–With the help of Yumi Teso.
(Updated Treasury yields.)
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