Tremors in Treasury bonds worry Wall Street and Washington

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

US Treasuries are a mainstay of the global financial system, but there are signs that the pool of interested buyers could be in danger of drying up as an unintended consequence of rising US interest rates.

No one is panicking yet. But the U.S. Treasury bond market has recently shown a level of volatility not seen since the start of the pandemic-related crisis in 2020, when the Federal Reserve cut interest rates to zero and continued to buy $1 trillion worth of Treasuries and other financial assets. ensure the functioning of the global financial system.

Top government officials have acknowledged in recent weeks that dysfunction in U.S. government bond markets could lead to higher federal government borrowing costs and broader turmoil in financial markets. They start taking preventive measures.

“We have taken a very close look at the Treasury market,” Treasury Secretary Janet L. Yellen told The Washington Post on Thursday, stressing that the market has continued to function normally. “Of course, it’s very important that it continues to do well.”

As fears of a recession mount, Washington is beginning to consider how to respond

The Treasury Department auctions bonds to pay for government operations, effectively borrowing money from investors in exchange for a guarantee of repayment with interest. These bonds are critical to a healthy financial system because other riskier assets, such as stocks and corporate bonds, are priced in relation to Treasury costs.

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

There has been no emergency so far, but the Treasury bond market is paying increased attention to concerns that as liquidity dries up around the world, at some point there may not be enough buyers of US government debt. As prices fall, the yield on 10-year government bonds has already risen from less than 1.5 percent to about 3.8 percent this year. (Bond prices and bond yields move in opposite directions.)

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Some economists and analysts warn that the lack of buyers could cause a ripple effect, pushing down the price of bonds. Panic selling of US Treasuries could wreak havoc on markets, giving investors the opportunity to demand higher returns or yields from buying bonds. This would mean higher prices for all types of financial instruments linked to these rates. It would also increase the cost of financing government debt.

As the Fed grapples with inflation, concerns are growing that it is overcorrected

“If we had a buyer’s strike or a failed series of Treasury auctions, interest rate hikes could accelerate — and suddenly credit card debt financing, car purchases, [and] housing would become more expensive,” said Joe Brusuelas, chief economist at management consultancy RSM. “It could lower the standard of living for Americans, and you could face a very difficult problem for your economy.”

Experts have also expressed other concerns. New rules enacted after the 2008 financial crisis have discouraged banks from acting as intermediaries, requiring them to hold more capital to cover potential losses on government securities. In addition, the Federal Reserve and other central banks are either selling Treasuries or simply not investing them anymore in an effort to cool the economy and fight inflation, eliminating one reserve buyer of US bonds.

And the recent panic in Britain over its sovereign debt, which recently saw a dramatic decline in value, prompting the Bank of England to intervene, has fueled fears that a similar market panic could occur here. But most economists downplay the risk.

“You’re worried about a sell-off, a situation where there’s a sell-off, and because there’s not enough demand, you have more sales and more sales, and you get kind of a spiral,” said Donald Kohn, a former deputy chairman of the federal government. Reserve Board and now a senior fellow at the Brookings Institution, a DC-based think tank. “I don’t think anybody sees that right now.”

“But the fact that traders may not be able to step in and smooth things out is a concern,” he noted.

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Analysts at JPMorgan Chase expressed similar concerns in a report this month, citing a lack of “structural demand.”

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

Long before the current flare-up, Yellen has focused on volatility in US bond markets, working to introduce new rules aimed at strengthening them. These measures include improving data collection; demanding greater oversight of the Treasury’s trading platforms; and expand the number of eligible distributors to allow more participants to participate in the market auction.

Despite Thursday’s comments emphasizing calm, Yellen appeared to be stepping up those efforts amid the latest signs of volatility. Treasury officials have asked traders in the market about a possible government debt buyback program, a possible sign that the US government is worried. The issue was also recently discussed by Yellen’s Financial Stability Oversight Board and is expected to come up at its next meeting.

Yellen’s main concern, she told Bloomberg News earlier this month, is the potential for “a loss of adequate liquidity in the market.”

But she also sees a countervailing trend: As the cost of government bonds rises, more foreign investors enter the market to absorb excess capacity.

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

Komal Sri-Kumar, president of Sri-Kumar Global Strategies, an economic consultancy, also thinks higher interest rates will make US debt more profitable for investors, attracting more buyers to the market and easing liquidity concerns.

And more broadly, many economists and financial analysts say concerns about market weakness may be overblown, especially now that a healthy level of U.S. government bonds — about $600 billion worth — are still traded daily.

Historically, warnings about the threat that investors will refuse to buy US government debt have not panned out. During the Obama administration, for example, Republicans and other deficit hawks said that large deficits could trigger a financial meltdown if bond buyers lost faith in the U.S. government. Such a crisis did not materialize.

Sri-Kumar calls these warnings “ridiculous.”

“If I refuse to buy [long-term] bonds, what happens then? Treasuries will have to offer higher yields and we will achieve a better balance,” Sri-Kumar said. “This is not Argentina, Zimbabwe or Turkey, where investors have said, ‘Interest rates are insufficient; keep hiking. Therefore, I believe that there is no point in the buyers’ strike.

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That sentiment was echoed by a senior Treasury official, who told The Washington Post that American policymakers have confidence in U.S. debt markets in part because so many investors around the world are scrambling to buy those bonds. There are countries that are the biggest buyers, including Japan, but even then they are only 4 percent of the total portfolio.

And while volatility in bond markets has increased, volatility is also affecting the financial sector more broadly, suggesting there is no specific risk to U.S. bonds despite their importance, a Treasury official said.

Poorer countries could suffer from US efforts to slow inflation

Recently, it was a different picture in Britain, where a large part of the country’s long-term public debt is held by pension funds. This made British bonds, or gilts, much more vulnerable to price swings as pension funds agreed to shed these assets as their value fell.

Analysts say this type of prevalence is lower in the United States.

“If you [expect] demand for a higher yielding asset will increase, [this] it would make the fear foolish 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 it … but there’s nothing on the horizon that is foreseeable to be a serious competitor to the US dollar. “

However, rising bond rates can hurt the US economy and government without causing disaster. If bond yields have to rise to attract investors, capital will flow into government debt and from more productive uses such as corporate debt, which encourages investment.

“The crisis scenario is a massive sell-off of these low-yield bonds. That would be a global financial crisis scenario,” said Mark Goldwein, senior vice president for policy at the Committee for a Responsible Federal Budget, a D.C.-based think tank. “But I think that’s unlikely. … The most likely scenario is that it’s going to be very expensive for the U.S. government and very expensive for the U.S. economy.

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