by Davide Barbuscia
NEW YORK (Reuters) – Investors are bracing for an influx of U.S. sovereign debt that could end up weighing on the expected rally in sovereign securities, as budget deficits continue to worsen across the Atlantic.
In recent months, movements in the rate market have mostly been linked to changes in the monetary policy expectations of the Federal Reserve (Fed), but concerns about fiscal sustainability could become more significant as the presidential election on November 5 is getting closer.
Analysts and observers indeed emphasize that reducing the public deficit is not a priority for either the Democratic camp or the Republican camp – something each camp denies.
Some investors are starting to hedge against a rise in sovereign yields that would be triggered by an imbalance between supply and demand. Others fear that the uncertainty around the volumes of debt that will have to be issued will end up destabilizing the Treasuries market, the basis of the current financial system and whose size reaches 27,000 billion dollars.
“If we ignore the Fed and the next six months, during which encouraging rate cuts could take place, the issuance volume is not healthy,” said Ella Hoxha, head of fixed income at Newton. Investment Management, which favors shorter maturities on sovereigns.
Yields on 10-year bonds could increase to 8% or 10% in the coming years, compared to 4.4% currently, which is “not sustainable”, she believes.
“Bond vigilantes,” investors who punish overspending governments by selling their securities, made a comeback last year and helped push the 10-year yield above 5% for the first time in 16 years. Concerns about the pace of issuance of American debt, however, calmed after the Treasury Department announced that it would spread out its issuance schedule last November.
In its latest announcement, the Treasury indicated that the volumes of each issue will be stable over the coming quarters. Analysts note, however, that markets are expecting an increase in issue volumes for long maturities from next year.
However, sources of demand for American securities are drying up, the Fed reducing the size of its balance sheet while the share of foreign investors in the holding of American debt is decreasing. The only exception, the volume of federal debt held by Americans could increase from 21,000 billion dollars currently to 48,000 billion in 2034, according to the Congressional Budget Office.
“We talk a lot about supply issues internally, but also questions about demand,” summarizes David Rogal, director and member of the multi-sector team at BlackRock.
“An environment in which demand is reduced and supply is increasing clearly makes me think that the term premium will increase,” he adds. The term premium is the additional remuneration demanded by investors when lending money over the long term.
Republicans and Democrats insist on wanting to reduce the deficit.
“While the previous administration added a record $8 trillion in debt without signing a single deficit reduction bill, President Biden approved a $1 trillion deficit reduction plan and plans to continue it. cut by another $3 trillion,” White House spokesman Jeremy Edwards said.
Anna Kelly, spokesperson for the Republican National Congress, says that “(Donald Trump’s) pro-growth, anti-inflation economic policies (…) will lower rates, deficit and debt levels in the long term.” .
“A PROBLEM FOR ANOTHER TIME”
A sudden drop in demand for Treasuries seems unlikely, as the dollar is the main currency used in foreign exchange reserves, while the depth and liquidity of the US sovereign market is unmatched.
“The most predictable crisis in history (…) is for the moment a silent crisis,” conclude JPMorgan analysts. “That’s a problem for another time, but not today.”
Some operators, however, took note.
If investor pressure pushes the Treasury to become less spending, the gap between yields on long and short maturities could widen, summarizes Jonathan Duensing, head of American bonds at Amundi US.
“We prefer the short, intermediate part of the curve, and we generally avoid exposure to the long part,” he explains.
Over the past year, investors have more frequently requested concessions from the Treasury to be able to buy its 10-year securities, while the term premium for this maturity briefly became positive again last month.
“Before the elections, it is better not to hold too many very long-term Treasury bonds,” notes Brij Khurana, bond manager at Wellington Management.
Other observers agree with the analysis.
Short-term debt “seems to be the safest investment in the event of an uncontrolled rise in deficits,” notes Craig Ellinger, head of American bonds at UBS Asset Management.
Kathryn Rooney Vera, head of strategy at StoneX, is positioning herself to benefit from a steepening of the yield curve because she believes more debt will put pressure on long-term yields.
“The answer would be to cut spending, and neither side wants to do that,” she concludes.
(Reporting Davide Barbuscia; French version Corentin Chappron, editing by Kate Entringer)
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