In recent years, the U.S. fiscal deficit has continued to rise, and the size of U.S. debt has snowballed. In October last year, a "U.S. debt storm" swept the global market. However, since then, with the expectation that the Federal Reserve will start to cut interest rates, the U.S. debt Against the backdrop of “unscrupulous” issuance, the U.S. bond market remains calm.

Yesterday, U.S. bond yields closed down across the board. The 2-year U.S. bond yield, which is more sensitive to interest rates, fell 3.5 basis points to 4.603%. The 10-year U.S. bond yield is currently at 4.239%, which is significantly higher than last year's high of 5%. fall back.

At the same time, demand for U.S. debt remains strong. According to EPFR data, capital inflows into U.S. debt ETFs reached the highest level since 2021 in the first week of March. According to weekly data from the Federal Reserve, in the two weeks as of March 13, the scale of commercial banks’ purchases of U.S. Treasuries also hit the largest two-week percentage increase since June 2020.

As the scale of bond issuance in the United States increased significantly in the second quarter of this year, will the silent "bond market vigilantes" (bond market investors sell bonds and raise yields to protest against monetary/fiscal policies that are worried about triggering inflation) will return with a vengeance? ?

U.S. debt issuance is "unscrupulous" and the U.S. debt market has increased to US$27 trillion

The U.S. fiscal burden continues to rise, and with it, the size of the U.S. debt continues to soar.

A previous article pointed out that the U.S. Congressional Budget Office (CBO) predicts that the U.S. debt-to-GDP ratio will exceed the peak level during World War II of 116% in 2029, and the debt level will rise to 166% of GDP by 2054.

When the government doesn't get enough money from taxes to cover spending, the Treasury Department issues bonds to fill the gap. The U.S. Treasury raised a net $2.4 trillion to cover the deficit last year.

Stephen Miran, an adjunct fellow at the Manhattan Institute for Policy Studies and a former senior adviser to the Treasury Department, pointed out that a deficit of nearly $2 trillion during a peacetime economic expansion requires a large amount of bonds for the market to absorb.

The annual issuance of U.S. Treasury bonds has surged. Since the end of 2019, the U.S. bond market has grown by more than 60%, reaching $27 trillion. The market has expanded approximately six times compared to before the 2008-09 financial crisis.

Entering 2024, the U.S. continues to issue bonds "unscrupulously." According to calculations by Goldman Sachs strategist Praveen Korapaty, the forecast for the net supply of U.S. debt (especially non-Fed investors who must absorb U.S. debt) is as follows:

US$358 billion in the first quarter, US$504 billion in the second quarter, US$546 billion in the third quarter and US$466 billion in the fourth quarter. From this point of view, the second quarter will see a significant increase, which is worthy of close attention (especially as the US election approaches), and there is a risk that the US short-term bond curve will steepen.

Looking ahead, government spending is widely expected to continue rising no matter who wins the November election, and few think the bond-issuing frenzy will slow down anytime soon. At the same time, as interest rates rise and debt service costs reach US$1 trillion in 2026, the bond market may "suddenly rebound."

Demand for U.S. debt is "unexpectedly" strong, and "bond market vigilantes" are silent?

The US$27 trillion U.S. debt market will only get bigger and bigger, but the demand for U.S. debt is "unexpectedly" strong. Have the "bond market vigilantes" deployed last year gone silent?

According to EPFR data, funds flowing into U.S. Treasury ETFs in the first week of March reached the highest level since 2021.

The U.S. banking industry is buying U.S. Treasury bonds at the fastest pace since the COVID-19 pandemic. According to weekly data released by the Federal Reserve, in the two weeks ending March 13, commercial banks purchased a total of $103 billion in U.S. Treasury bonds and federal agency non-mortgage securities. Loan-backed securities.

This data is regarded by analysts as a barometer of demand for U.S. debt. According to statistics from RBC, the indicator recorded the largest two-week percentage increase since June 2020.

Analysis points out that there are three reasons for the strong demand for U.S. debt:

First, hedge funds and individual buyers have largely filled the gap left by the Federal Reserve. However, new SEC regulations are likely to reduce the profitability of Treasury futures. The hedge fund industry is filing lawsuits, and funds are also Disinvestment has already begun.

Second, banks have been reducing their purchases of Treasury bonds for years, and the International Swaps and Derivatives Association trade group recently asked the Fed to reinstate an epidemic-era policy that allows banks to exclude Treasury bonds and central bank deposits from regulatory buffers. The buffer zone forces banks to hold a certain percentage of capital in loans and other assets. This would allow banks to finance more Treasuries and open up their balance sheets if markets tighten.

Third, there are fewer alternatives. Many companies issued long-term bonds when interest rates were low and slowed borrowing after the Fed raised interest rates. The market for mortgage-backed securities is all but frozen, and few Americans are moving in the most expensive housing market in decades.

As the scale of U.S. debt issuance continues to grow, demand has unexpectedly strengthened. "Bond market vigilantes" have been absent from the current market, and U.S. bond yields have continued to fall in recent months.

The term "bond market vigilantes" was first coined by Yardeni Research President Ed Yardeni in 1980, when bond traders punished the profligate federal government by selling bonds, and concerns about federal spending pushed U.S. Treasury yields higher. as high as 8%.

Last fall, the long-dormant "bond market vigilantes" returned to confront the Federal Reserve and the U.S. federal government. The yield on the 10-year U.S. Treasury note exceeded 5%, reaching its highest level since 2007. But since then, demand has begun to rise, investors have not needed additional compensation to hold longer-dated Treasuries, and the term premium has effectively become negative.

Bob Michele, chief investment officer and global head of fixed income, currencies and commodities at JPMorgan Chase, said:

Concerns about supply and "bond market vigilantes" are complete nonsense, I see no evidence of it, and for at least the last six months clients have been asking us where do I get into the bond market? When should I enter the bond market? Everyone has money to invest in bonds.

Rising inflation and concerns about fiscal folly persist

Still, worries about higher inflation and fiscal folly (excessive government spending leading to larger fiscal deficits and rising debt levels) still hang over the U.S. bond market.

Ken Griffin, the billionaire founder of hedge fund Castle Investments, echoed many investor concerns about the government's massive spending and debt issuance plans when he told an industry conference this month that the U.S. bond market should be subject to some discipline. . He told a Florida Futures Industry Association gathering:

U.S. government spending is “already out of control,” and unfortunately when sovereign markets start to bring the hammer down on discipline, that can be pretty brutal. "

Andrew Balls, chief investment officer of investment group Pimco, also recently revealed that the company’s U.S. Treasury bond positions are lower than usual and prefers bonds from the United Kingdom, Canada and other countries. Pimco noted:

Inflationary pressures may cause the Federal Reserve to cut interest rates more slowly than other major central banks. In addition, neither Democrats nor Republicans seem concerned about the level of fiscal deficits. Term premiums are likely to slowly increase in favor of longer-dated government bonds outside the United States.

It is worth mentioning that Bowles is also worried about a repeat of the surge in yields last fall. When talking about the rise in yields last fall, Bowles said, "At that time, the market was worried that the government borrowing plan would exceed expectations. You can imagine this It will happen again."

Analysis points out that if effective measures are not taken to address the expanding debt problem, investors will face higher bond yields in the long term. The current global economic situation, including the risk of war, expansionary fiscal policies, deglobalization trends and inflationary pressures caused by immigration, all indicate that interest rates will increase and remain at a higher level than before the epidemic. For long-term bond investors, the key is assessing how long the high-rate environment will last.

The challenges faced by investors are not limited to the issue of scale growth. Some people have expressed concerns about changes in trading rules. These changes may help ease tensions, but may also cause some unforeseen consequences, such as cash in 2019 and 2020. Shortages result in transaction barriers and rising interest rates.