Tremors in Treasury bonds worry Wall Street and Washington

Explanation

Trouble is brewing in the world of U.S. Treasury bonds, worrying investors and some Washington politicians.

US Treasuries are a key pillar of the global financial system, but there are signs that the pool of interested buyers could be at risk of drying up as an unexpected result of rising US interest rates.

At the moment, no one is panicking. But the U.S. Treasury bond market has recently shown the level of volatility it has seen since the start of the pandemic-related crisis in 2020, when the Federal Reserve cut interest rates to zero and went on a $1 trillion purchase of Treasuries and other financial assets. to keep the global financial system functioning.

Senior government officials have acknowledged in recent weeks that volatility in the US government bond markets risks increasing the federal government’s borrowing costs and broader volatility in financial markets. They start taking preventive measures.

Janet L. “We’ve been watching the Treasury market very closely,” Treasury Secretary Yellen told The Washington Post on Thursday, stressing that the market is operating normally. “Of course, it’s important that it works well.”

As fears of a recession grow, Washington is beginning to weigh how to respond

The Treasury Department auctions bonds to pay for government operations, effectively borrowing money from investors in exchange for guaranteed interest repayments. These bonds are critical to a healthy financial system because other risky assets—stocks and corporate bonds—are priced relative to the value of Treasurys.

But as central banks such as the Federal Reserve engage in one of the biggest rate hikes in decades, demand for already outstanding U.S. Treasuries has weakened in part because most of these loans have lower interest rates than the bonds issued. . today This could mean more low-cost, low-income loans with fewer buyers.

So far, there has been no emergency, but the Treasury bond market is drawing more attention on concerns that as liquidity dries up around the world, there may not be enough buyers of U.S. government-issued debt in some cases. As rates have fallen, the yield on the 10-year Treasury note has already risen from less than 1.5 percent to about 3.8 percent. (Bond prices and bond yields move in opposite directions.)

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Some economists and analysts warn that a lack of buyers could cause bond prices to fall. Panic selling of US Treasuries can disrupt markets – allowing investors to demand higher yields or yields by buying bonds. This means higher prices for all types of financial instruments linked to these prices. It also increases the cost of the government to finance its debt.

As the Fed grapples with inflation, concerns mount that it will overcorrect

“If we have a buyer’s strike or a series of Treasury failure auctions, interest rate hikes could accelerate — and suddenly, credit card debt financing, car purchases, [and] “It’s going to be more expensive to buy a home,” said Joe Brusuelas, chief economist at management consultancy RSM. “That could reduce the standard of living for Americans, and you could be facing very difficult challenges for your economy.”

Experts have raised other concerns as well. New regulations passed after the 2008 financial crisis bar banks from acting as intermediaries, preventing them from requiring more capital to cover potential losses on government securities. In addition, the Federal Reserve and other central banks are either selling Treasuries or no longer reinvesting them, as part of their efforts to cool the economy and fight inflation, leaving a back-up buyer of US bonds.

And the recent panic in Britain over its sovereign debt – which recently fell sharply and prompted the Bank of England to intervene – has raised concerns that a similar market panic could occur here. But most economists downplay the risk.

“You get a fire sale, a situation where some sales occur and because there’s not enough demand, you sell more and you have more sales and you get a kind of spiral,” said Donald Cohn, a former deputy chairman of the Fed. Donald Cohn. Board of Governors of the Reserve Bank and is now a senior fellow at the Brookings Institution, a DC-based think tank. “I don’t think anyone sees that now.”

“But the fact that the dealers don’t have the ability to come in and smooth things over is a concern,” he said.

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

“The change in demand was surprising because it was so small,” they added.

Yellen has focused on volatility in US bond markets since before the current flare-up, working to implement new rules aimed at strengthening them. These measures improve data collection; requiring greater oversight of treasury trading platforms; and expanding the number of eligible dealers to allow more market participants.

Despite her remarks on Thursday emphasizing calm, Yellen appeared to be stepping up those efforts amid recent signs of volatility. Treasury officials asked market traders about a possible government bailout program, a possible sign of concern from the U.S. government. This issue was also recently discussed at the Financial Stability Oversight Board, chaired by Yellen, and is expected to be raised at its next meeting.

A key concern for Yellen, she told Bloomberg News this month, is the potential for “a loss of adequate liquidity in the market.”

But he also sees a countertrend: As yields on Treasury bonds rise, foreign investors are entering the market to absorb excess capacity.

“You asked who’s buying 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 believes that higher interest rates will make US debt more profitable for investors, attracting more buyers to the market and reducing liquidity concerns.

And more broadly, many economists and financial analysts say worries about market weakness may be overblown, especially now that a healthy level of U.S. government bonds — about $600 billion — continues to trade daily.

Historically, awareness of the risk of defaulting on US government debt has not persisted. For example, during the Obama administration, Republicans and other deficit hawks said that large deficits would cause bond buyers to lose confidence in the US government. Such a crisis did not occur.

Sri-Kumar called the warnings “ridiculous”.

“If I refuse to buy [long-term] bonds, so what? The treasury should offer higher yields and we will achieve a better balance, “said Sri-Kumar. “This is not Argentina or Zimbabwe or Turkey, where investors have said: ‘The interest rate is insufficient; keep walking.'” Therefore, I think that the strike of buyers does not make sense.”

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That sentiment was echoed by a senior Treasury official who told The Washington Post that US policymakers have confidence in US debt markets in part because many investors around the world want to buy those bonds. There are countries that are major buyers, including Japan, but even then, it only accounts for 4 percent of the total pool.

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

Poor countries may suffer from US efforts to reduce inflation

More recently, the picture was different in Britain, where most of the country’s long-term public debt was held by pension funds. This made British bonds, or gilts, more vulnerable to price swings as pension funds scrambled to buy those assets after their value fell.

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

“If you [expect] demand for high-yielding assets increases, [this] makes the fear seem foolish or misguided,” said Bob Hockett, a former Fed official and public policy expert now at Cornell University. be.”

However, a rise in bond yields could damage the US economy and government without causing disaster. If bond yields rise to attract investors, capital will flow into government debt – and away from more productive uses, such as corporate debt, which boosts investment.

“The crisis scenario is a sudden selloff 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 DC-based think tank. “But I think it’s unlikely. … The more 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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