“Justicemen” stalk the battered US Treasury debt market

The growing concern of investors by US public spending and its large budget deficit is contributing to a strong sell-off, which has driven commodity prices Treasury bond at a minimum of 17 years.

The calls “bond vigilantes”, investors punishing wasteful governments by selling their bonds – driving up yields – were a feature of markets in the 1990s, when concerns about US federal spending drove Treasury yields to 8%.

The anticipation of an increase in the US government’s spending deficit and more debt issuance to cover it has unsettled investors and returned the term to the everyday lexicon of Wall Street.

Recently cutting the country’s credit rating, Fitch forecast that the US deficit would rise to 6.3% of gross domestic product (GDP) this year, from 3.7% in 2022, due to higher debt service costs. new spending initiatives and weak federal revenues.

While the Federal Reserve’s interest rate forecasts have been a catalyst driving yields higher and weighing on prices, market players attribute some of the selloff in longer-term debt to investors. wary of increased spending.

Yields on 30-year U.S. Treasury bonds – which move inversely to prices – soared as high as 5% on Wednesday for the first time since 2007 in a broad wave of global debt selling, before stabilizing .

“There is concern that if government spending is not reduced now, how big is it going to be if we hit another recession and the deficits could be very significant and (…) with a significant amount of supply (of Treasuries)said Gene Tannuzzo, global head of fixed income at Columbia Threadneedle.

Fiscal concerns have been growing since the summer, when the Treasury announced plans to increase debt issuance.

The total size of Treasury auctions will increase an average of 23% across all maturities in 2024, according to Apollo Group estimates. At the same time, the Federal Reserve is advancing the “quantitative tightening”, a reversal of the massive central bank bond purchases undertaken to support markets in 2020.

The 156% increase in the federal deficit in the last year has been due to the drop in public revenue due to lower capital gains and lower 2022 salary bonuses, as well as the sharp increase in tax refunds, according to the Department of the Treasury.

Public spending increased 10% in the period, driven by higher Social Security payments and increased debt expenses.

“People are realizing that interest expenses alone are increasing at a rate that is not sustainable“, said Jake Remleyfrom the asset manager Income Research and Management from Boston.

Strategist Ed Yardeni, who coined the term “bond vigilantes” in the early 1980s, has also intervened.

“Bond vigilantes have been challenging (Treasury Secretary Janet) Yellen’s policies by raising bond yields to levels that threaten to create a debt crisis.” he said in an op-ed in the Financial Times on Wednesday.

“In this scenario, higher yields crowd out the private sector and trigger a credit crunch and recession.”.

In the United Kingdom, resistance from fixed-income investors helped force a U-turn in monetary policy last year after a plan to cut taxes sent borrowing costs soaring, showing that vigilantes fixed income remain a force to be reckoned with.

However, not all investors believe vigilantes are capable of influencing the $25 trillion Treasury market.

Famed bond investor Bill Gross, co-founder of Pacific Investment Management Co (Pimco), said bond vigilantes will have a muted effect now, given the Federal Reserve’s increased role in markets.

Bond investorsThey are more like helpless pawns in this chess game of interest rates.“he told Reuters by email.

“The mighty kings (the Fed) and queens (the Treasury) control the board with inflation and the huge future supply of Treasuries, leading to a potential checkmate of higher yields and lower stock prices.”.

Greg Whiteley, portfolio manager at DoubleLine, believes concern about rates, rather than Treasury supply, is a key driver of the sell-off. Some fund managers are waiting for a spike in yields before intervening, he said.

“Government finances are a disaster, but that’s not the main reason people are selling bonds now“, said.

The recent selloff has returned yields to pre-financial crisis levels, increasing the appeal of bonds overall and boosting investor returns, said Robert Tipp, chief investment strategist and head of global bonds at PGIM.