The United States is expected to flood the market with long-term bonds next year, raising the question of who will buy the debt and at what price.
The Treasury Department plans to sharply shift its bond sales to maturing debt in the future, as the government seeks to fund large spending programs.
Investors will have to gobble up $ 1.8 billion in Treasuries with maturities greater than one year, even after factoring in the Federal Reserve’s massive bond-buying program, JPMorgan estimates. This will mark a stark contrast to this year, when a much larger share of Treasury issuance was in the form of short-term debt.
With higher growth and inflation expectations in 2021, strategists say the US may be forced to offer higher interest rates on these longer-term securities to get investors to buy the debt. .
“When we add the numbers up, we have a pretty big demand gap,” cautions Jay Barry, managing director of JPMorgan’s interest rate strategy team. “We believe that a slight increase in yields will be necessary to encourage demand.”
T-bills serve as a key benchmark for other types of debt, which means that rising U.S. government borrowing costs could spill over into the entire fixed-income landscape. Higher returns are also one of the main risks to the equity market, analysts said.
The deluge of long-term Treasury bill sales comes at a time when investors have already turned to riskier, higher-yielding corners of financial markets in anticipation of a robust economic rebound next year and as the Fed continues to take steps to keep financial conditions loose.
As a result, US government bond prices fell, bringing yields close to their nine-month highs. Longer-term Treasuries carried the brunt of the sell-off, with 10-year Treasury yields falling from less than 0.7% in early October to just under 1%.
According to analysts and investors, the chances of a dramatic rise in borrowing costs are low. The Treasury has already funded the $ 900 billion stimulus package that President Trump signed this week, according to Jefferies, and is currently on a record pile of $ 1.5 billion. The issuance of short-term debt instruments, known as bills, is also expected to decline next year, several bond strategists have said.
But investors believe that the “supply overhang” of long-term Treasuries – as Subadra Rajappa, head of US rate strategy at Société Générale describes it – coupled with the specter of resuming growth and inflation will push treasury prices even lower next year. Ms. Rajappa expects 10-year yields to rise by up to 1.5 percent.
Expectations of higher yields stem in part from the Fed’s reluctance to expand its presence in the US government debt market.
Ahead of its last monetary policy meeting, a cohort of Wall Street bankers and economists called on the Fed to shift most of its bond-buying program to longer-term Treasuries in order to guarantee that financial conditions remain easy despite the huge issuance scheduled for next year. He held on, letting investors absorb the extra offer.
Foreign buyers are expected to absorb some of this, although they have played a much smaller role in the market in recent years. At 35%, their Treasury debt holdings are at their lowest level in nearly 20 years, according to Fed data. Part of the purchase is likely to come from Japanese investors as their holdings of domestic government debt are guaranteed to make a loss if held to maturity, said Olivia Lima, rate strategist at the Bank. of America.
Banks are also expected to follow a record year of Treasury demand with a new wave of buying. Barry is forecasting $ 200 billion for 2021, with an additional $ 175 billion coming from pension funds and insurance companies. That still leaves a deficit of $ 644 billion, according to Barry’s calculations based on the overall Treasury issuance, even after other sources of demand are factored in.
Given the gap, Kathy Jones, chief fixed income strategist at Charles Schwab, said the Treasury Department will have to pay to sell its long-term debt.
“The demand will be there,” she said. “It just depends on how it’s rated.”
The second round of elections in Georgia could further worsen the imbalance between supply and demand for the Treasury. If Democrats are able to win both races in January and take control of the Senate, more aggressive spending programs – and therefore heavier emissions – could be in sight next year.
Goldman Sachs, which advocates so-called “steepening the curve” bets that benefit if long-term yields rise faster than short-term ones, called the election the “next major source of event risk for the equity market. rate”.
Too far, too rapid a move in long-term Treasuries yields that is driven more by supply and demand issues than by the prospect of faster growth will not go unnoticed by the Fed.
The central bank may need to shift its bond purchases toward longer-term debt or even scale up its bond purchase program “if markets start to struggle to reduce supply. first half, “said Blake Gwinn, Head of Short Term Interest Rate Strategy at NatWest Markets.
This would end any sale of the Treasury, added Oliver Brennan, senior macro-strategy strategist at TS Lombard. “How the Fed decides to structure its demand will have the biggest impact on the market.”