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A step-up in borrowing by the US government has deepened a decline in bond markets, driving yields to their highest point since 2007, according to analysts and investors.
The recent bond rout can be attributed partly to a shift in expectations regarding interest rates and economic expansion. Friday’s data revealing strong US job growth has added to concerns about the need for high interest rates to combat inflation, putting further pressure on bond prices.
Investors and analysts point out that the surge in bond yields is also a result of increased issuance of new debt, especially for longer-dated bonds which have been hit the hardest. However, demand from major Treasury buyers such as foreign investors, foreign central banks, and US banks has stagnated.
While historically the supply of Treasuries hasn’t been a major driver of bond yields, the current surge is occurring as the US Federal Reserve steps back from the market, making it the largest buyer of Treasury bonds. Andrew McCaffery, Chief Investment Officer at Fidelity International, remarks, “We’ve seen an extraordinary level of issuance and little indication of any fiscal tightening in the future. The market is signaling that the US cost of borrowing needs to increase.”
To address widening budget deficits and compensate for lower tax revenue, the US government has ramped up its borrowing this year, with around $1 trillion of bonds expected to be issued by October. The Securities Industry and Financial Markets Association (Sifma) reports that net issuance has already reached $1.8 trillion this year, making it the second-highest tally on record after the early stages of the pandemic in 2020 when the Federal Reserve purchased a significant amount of bonds through its asset purchase program.
Issuance is projected to continue increasing, with Torsten Slok, Chief Economist at Apollo Global Management, expecting average Treasury auction sizes to rise by 23% in 2024.
The scale of borrowing hasn’t come as a surprise to bond investors, as the Treasury department announced its plans in August. However, the market has only gradually adjusted to the relentless issuance. Meghan Swiber, US Rates Strategist at Bank of America, acknowledges, “We are aware of what the supply numbers from the Treasury look like, and we have a good sense of the projected deficits. But the actual impact of that supply on the market didn’t hit us immediately, and a lot of that impact is still to come.”
The supply of Treasuries had already experienced a significant increase since the global financial crisis, driven by increased issuance to fund tax cuts under former President Trump and pandemic-related spending. The Treasury market is now approximately $25 trillion in size, five times its value at the beginning of 2008. The higher borrowing costs resulting from this surge will add to the government’s expenses.
Despite the increase in supply, foreign investors and foreign central banks, who are crucial demand drivers in the Treasury market, have maintained relatively steady purchases over the past year, according to Exante Data. However, their holdings as a percentage of the total Treasury market have decreased. Demand from Japan and China, the two largest foreign holders of Treasuries, remains stable but has decreased in proportional terms, according to Brad Setser, a Senior Fellow at the Council on Foreign Relations.
A similar trend can be observed among US banks, historically major buyers of Treasury bonds. Data from the Fed reveals that banks’ holdings of Treasuries and agency
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