US bondholders face supply threat

Higher inflation and a tapering of central bank bond-buying programmes are not the only threats to the holders of US government bonds. One worry, a wave of supply, is being flagged by economists and strategists.

Economists with Deutsche Bank expect the extra debt the Treasury must issue to fund President Donald Trump’s tax package and the amount of debt the Federal Reserve plans to redeem at maturity this year will bloat issuance to about $1tn in 2018. That’s up more than 50 per cent from a year earlier and, when coupled with a 30 per cent rise in the amount of corporate debt that’s due to mature, leaves questions of who the eventual buyer will be.

“If demand for US fixed income doesn’t double over the coming years then US long rates will move higher, credit spreads will widen, the dollar will fall, and stocks will probably go down as foreigners move out of depreciating US assets,” said Torsten Sløk, an economist with the bank.

That extra supply should arrive as central banks withdraw crisis-era stimulus. Robert Michele, JPMorgan Asset Management’s global head of fixed income, expects that support to “fade away”. “You’ll have to find someone else who wants to step up at these levels.”

Not all strategists agree that supply will be a culprit for higher rates. Those at Morgan Stanley note that Treasury prices have already declined and the yield curve has already flattened, reflecting the expected increase in supply. The team at the New York-based bank expects the US Treasury to rely to a large extent on issuance of short-dated bills and two-, three- and five-year notes. That would limit a surge of issuance of new 10- and 30-year Treasuries, tempering some of the pressure on yields further out the curve.

“The Treasury supply story is a red herring for higher yields,” Morgan Stanley strategist Matthew Hornbach said. “Market prices adjust most when expectations are formed for the additional supply. Prices adjust much less on an outright basis when the actual supply hits the market.”

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