Ahead of this year’s presidential election, investors anticipate a deluge of U.S. government debt issuance that, over time, may dwarf an anticipated bond rise. This is because they see no end in sight for significant budget deficits.

Although speculations on the extent to which the Federal Reserve will be able to lower interest rates have dominated the bond markets thus far this year, as the election on November 5 draws closer, fiscal worries should start to take centre stage. According to investors and analysts, President Joe Biden and his Republican opponent, Donald Trump, do not seem to view cutting the deficit as a top priority. The teams of both candidates contest this idea.

As a result of supply and demand mismatches, some investors have already begun allocating funds in a way that would protect them from losses should Treasury yields—which move inversely to prices—start to rise. Others fear that the $27 trillion Treasury market, which is the cornerstone of the global financial system, may become unstable due to the lack of clarity about the precise amount of debt required for deficit spending.

According to Ella Hoxha, head of fixed income at Newton Investment Management, who advocates for short-term Treasuries maturities, “supply numbers are not healthy if we take a step back away from the Fed and away from the next six months where we could still get substantial rate cuts.”

According to her, benchmark 10-year Treasury rates, which are now at 4.4%, might go to 8%–10% over the next years. “Longer term, it’s not sustainable.”

The 10-year Treasury yield reached 5% for the first time in 16 years last year due to the return of “bond vigilantes,” investors who punish wasteful governments by selling their bonds. However, worries about the increasing amount of U.S. debt issued decreased when the Treasury Department slowed down the rate of increases in November.

The Treasury Department announced this month that it intends to maintain constant auction sizes throughout the next quarters in its most recent refunding notice. However, experts have stated that larger auctions for long-dated debt are anticipated as early as next year.

The Congressional Budget Office estimates that by 2034, the public’s portion of the federal debt might increase by $21 trillion to $48 trillion. opens new tab. In the meanwhile, demand for US government bonds isn’t coming from the same old places. The market is becoming larger, but foreign ownership is not keeping up, and the Fed is continuously reducing the amount of bonds it owns.

“We’ve been discussing demand as much as supply internally,” stated David Rogal, a managing director in BlackRock’s global fixed income department who leads the multi-sector team.

The term premium is a measure of the additional payment investors seek in exchange for long-term government loans. “An environment where you have a reduced buyer base and more supply definitely makes me think that over time you will see more term premium,” he added.

Both Republicans and Democrats have pledged to lower debt levels and deficit spending.

“After the prior administration increased the debt by a record $8 trillion and didn’t sign a single law to reduce the deficit, President Biden has signed $1 trillion of deficit reduction into law and has a plan to lower the deficit by $3 trillion more,” Jeremy Edwards, a spokeswoman for the White House, said.

According to Republican National Committee spokesperson Anna Kelly, Trump’s “pro-growth, anti-inflation economic policies will… bring down interest rates, shrink deficits, and lower long-term debt levels.”

Given the scale and depth of the Treasuries market and the dollar’s position as the primary reserve currency, a dramatic decline in demand for US government bonds seems improbable.

“The most predictable crisis in history … is for the moment more a silent crisis,” JPMorgan analysts said in a recent note. “A problem ‘for tomorrow’ but not right now,” they wrote.

However, some players in the industry have begun to adjust.

Higher long-term rates compared to shorter-term ones would be an indication of investor pressure on the Treasury Department to become more fiscally conservative, according to Jonathan Duensing, head of U.S. fixed income at Amundi US.

“We’re much more in the front end and intermediate part of the yield curve right now and prefer to stay away in general from the longer-duration part of the Treasury curve,” he stated.

Investors have been demanding concessions to purchase the paper more frequently than in previous years at 10-year Treasury auctions, which is a symptom of declining demand. In the meanwhile, last month saw a temporary return to positive territory for the 10-year Treasury term premium, opens new tab.

“Ahead of the elections you probably don’t want to be owning as much very long-dated U.S. Treasuries,” said Brij Khurana, a fixed income portfolio manager at Wellington Management.

These worries were shared by others.

According to UBS Asset Management’s Craig Ellinger, head of Americas fixed income, short-term debt “seems like the safer place to be in case deficits do get out of control.”

Chief market strategist at StoneX Kathryn Rooney Vera is preparing for a steeper yield curve in part because she believes significant issuance will put pressure on long-term Treasuries.

“The answer is reducing spending, and neither side wants to do that,” she stated.

(Adapted from EconomicTimes.com)

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