Tremors in Treasury bonds worry Wall Street and Washington

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Trouble is brewing in the US Treasuries world, causing concern among investors and some policymakers in Washington.

US Treasuries are a key pillar of the global financial system, but there are signs that the pool of interested buyers may dry up as an unintended consequence of rising US interest rates.

So far, no one is panicking. But the US Treasuries market recently displayed a level of volatility not seen since the start of the pandemic crisis in 2020, when the Federal Reserve cut interest rates to zero and then bought for 1,000. billions of dollars in treasury bills and other financial assets. to keep the global financial system functioning.

Senior government officials have acknowledged in recent weeks that dysfunctional U.S. government bond markets risk triggering a spike in federal government borrowing costs and a broader upheaval in financial markets. They begin to take preventive measures.

“We have been watching the Treasury market very carefully,” Treasury Secretary Janet L. Yellen told The Washington Post on Thursday, noting that the market had continued to operate normally. “It is of course essential that it continues to function well.”

As recession fears grow, Washington begins to weigh how to respond

The Treasury Department auctions bonds to pay for government operations, in effect borrowing money from investors in exchange for a guarantee of repayment with interest. These bonds are crucial for a healthy financial system because other, riskier assets – stocks and corporate bonds – are priced against the cost of treasury bills.

But as central banks such as the Federal Reserve engage in one of the biggest interest rate hikes in decades, demand for US government bonds already in circulation has fallen in part because most of that debt carries lower interest rates than bonds issued today. This could mean a glut of cheap, low yielding debt with few buyers.

There has been no urgency so far, but the Treasuries market is attracting more and more attention on fears that as liquidity dries up around the world, it may ‘at some point there aren’t enough buyers of US government-issued debt. With prices falling, 10-year Treasury yields have already risen from less than 1.5% to around 3.8% this year. (Bond prices and bond yields move in opposite directions.)

A shortage of buyers could cause a ripple effect by driving down bond prices, some economists and analysts warn. A panicked sale of US Treasuries could wreak havoc on markets, giving investors leverage to demand yields or higher yields on their bond purchases. This would mean higher prices for all sorts of financial instruments pegged to these rates. It would also increase the cost to the government of financing its debt.

As the Fed battles inflation, fears of overcorrecting

“If we were to have a buyers’ strike or a failed round of Treasury auctions, interest rate increases could accelerate – and all of a sudden credit card debt financing, purchases cars, [and] housing purchases would increase in cost,” said Joe Brusuelas, chief economist at management consultancy RSM. “It could lower the standard of living for Americans and you could end up with a very difficult problem for your economy.”

Experts also raised other concerns. New regulations enacted after the 2008 financial crisis discouraged banks from acting as intermediaries by requiring them to hold more capital to cover potential losses on government securities. In addition, the Federal Reserve and other central banks are selling Treasuries or simply not reinvesting them any more, as part of their attempts to cool the economy and fight inflation, removing a supportive buyer from US bonds.

And the recent panic in Britain over its own public debt – the value of which has recently fallen dramatically, leading to intervention by the Bank of England – has further amplified fears that a similar market panic could happen here. But most economists downplay the risk.

“You worry about the sellout, the situation where some sales are coming in and because there’s not enough demand, you have more sales and more sales and you get kind of a spiral,” Donald said. Kohn, former Vice President of the Federal Government. Reserve Board of Governors and now a senior fellow at the Brookings Institution, a DC-based think tank. “I don’t think anyone sees that right now.”

“But the fact that dealers may not have the ability to step in and smooth things over is concerning,” he noted.

JPMorgan Chase analysts expressed similar concerns in a report this month, citing the lack of “structural demand for.”

“The reversal in demand has been amazing because it has been rare,” they added.

Yellen focused on instability in US bond markets long before the current surge, working to implement new rules aimed at strengthening them. These measures include improving data collection; demand more oversight of Treasury trading platforms; and increasing the number of eligible dealers to allow more entrants to bid on the market.

Despite his Thursday comments emphasizing calm, Yellen appears to be stepping up those efforts amid the latest signs of volatility. Treasury officials have asked market traders about a possible government debt buyback program, a potential sign that worries the US government. The issue was also recently discussed by the Financial Stability Supervisory Board, which Yellen chairs, and is expected to be addressed at its next meeting.

A key concern for Yellen, as she relayed to Bloomberg News this monthis the possibility of an “adequate loss of liquidity in the market”.

But she also sees a contrary trend: as payments on Treasuries increase, more and more foreign investors are entering the market to absorb the excess capacity.

“You asked who was going to buy Treasuries, and I think part of the answer is that they have very attractive yields,” Yellen said Thursday.

Komal Sri-Kumar, chairman of economic consultancy Sri-Kumar Global Strategies, also believes higher interest rates will make US debt more lucrative for investors, bringing more buyers into the market and allaying concerns about liquidity.

And more generally, many economists and financial analysts say worries about market weakness may be overblown, especially at the moment when healthy levels of US government bonds – worth around $600 billion dollars – continue to be traded every day.

Historically speaking, warnings about the danger of investors refusing to buy US government debt have not held true. Under the Obama administration, for example, Republicans and other deficit hawks have declared that large deficits would risk triggering a financial collapse if bond buyers lost faith in the US government. No such crisis materialized.

Sri-Kumar calls these warnings “a ridiculous thing”.

“If I refuse to buy [long-term] obligations, what happens then? The Treasury will have to offer a higher return, and we are achieving a better balance,” Sri-Kumar said. “It’s not Argentina, Zimbabwe or Turkey, where investors have said, ‘Interest rates are insufficient; keep hiking. That’s why I think a buyers’ strike doesn’t make sense.

That sentiment was underscored by a senior Treasury official, who told The Washington Post that U.S. policymakers have confidence in U.S. debt markets in part because so many investors around the world are looking to buy those bonds. There are countries that are big buyers, among them Japan, but even then, it’s just 4% of the total pool.

And while volatility is on the rise in bond markets, volatility is also hitting the financial sector more broadly – ​​suggesting no specific risk for US bonds despite their outsized importance, the Treasury official said.

Poorer countries could suffer from US efforts to slow inflation

The situation was different recently in Britain, where much of the country’s long-term public debt was held by pension funds. This made UK bonds, or gilts, much more vulnerable to price swings as pension funds moved in unison to dump these assets as their value fell.

This type of contagion is less likely to emerge in the United States, analysts say.

“If you [expect] demand will increase for a higher yielding asset, [this] would make the fear a bit silly or misplaced,” said Bob Hockett, a former Fed official and public policy expert now at Cornell University. “I don’t want to be complacent about this…but there’s nothing foreseeable on the horizon that’s a serious competitor to the US dollar.”

Yet rising bond yields can hurt the US economy and government without causing catastrophe. If bond yields have to soar to attract investors, capital will flow into public debt – and out of more productive uses, such as the corporate debt that fuels investment.

“The crisis scenario is a massive sell-off of these low-yielding bonds all at once. That would be the scenario of a global financial crisis,” said Marc Goldwein, senior vice president for policy at the Committee for a Federal Budget. responsible, a Washington-based think tank.”But I think it’s unlikely. … The most likely scenario is that it will cost the US government a lot of money and the US economy a lot of money.”

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