Tremors in Treasury bonds worry Wall Street and Washington

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Trouble is brewing in the world of US Treasury bonds, prompting concern among investors and some policymakers in Washington.

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

For now no one is panicking. But the US 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 -interest to zero and continued to buy $1 trillion of treasuries and other financial assets. to keep the global financial system running.

Top government officials have acknowledged in recent weeks that dysfunction in US government bond markets risks leading to a rise in federal government borrowing costs and wider turmoil in financial markets. . They are starting to take preventive steps.

“We have been watching the Treasury market very carefully,” Treasury Secretary Janet L. Yellen told The Washington Post on Thursday, stressing that the market continued to function normally. “It is, of course, critical that it continues to work well.”

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The Treasury Department auctions bonds to pay for government operations, effectively borrowing money from investors in return for a guarantee of repayment with interest. These bonds are crucial to a healthy financial system, because other riskier assets — stocks and corporate bonds — are priced in relation to the cost of the Treasury.

But as central banks like the Federal Reserve embark on one of the biggest interest rate hike campaigns in decades, demand for US government bonds that were already in circulation has decreased in part because much of that debt has lower interest rates than the bonds being issued. today. This can mean a large amount of cheap, low-yielding debt with few buyers.

So far there has been no emergency, but the market for Treasury bonds is drawing more attention because of concerns that as liquidity dries up around the world, there may at some point not be enough buyers. of debt issued by the United States government. With prices falling, yields on 10-year Treasury bonds have already risen from less than 1.5 percent to roughly 3.8 percent this year. (Bond prices and bond yields move in opposite directions.)

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The lack of buyers can cause a ripple effect by forcing down the price of bonds, warn some economists and analysts. A panic sell-off of US Treasuries could wreak havoc on markets — giving investors leverage to demand a higher return, or yield, on their bond purchases. This would mean higher prices for all types of financial instruments linked to those rates. It also raises the cost to the government of financing its debt.

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“If we had a buyers’ strike, or a failed series of Treasury auctions, interest rate hikes could accelerate — and suddenly, credit card debt financing, purchases of cars, [and] buying homes will go up in cost,” said Joe Brusuelas, chief economist at management consultancy RSM. “This could lower living standards for Americans, and you could find yourself with a very difficult problem for your economy.”

Experts have raised other concerns as well. New regulations enacted after the 2008 financial crisis discouraged banks from acting as intermediaries by 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 Treasurys or simply not reinvesting them, as part of their attempts to cool the economy and fight inflation, removing one backstop buyer of ‘ United States bonds.

And the recent panic in Britain over its own government debt – which has recently fallen dramatically in value, prompting intervention by the Bank of England – has further amplified concerns that a similar panic could occur in -market here. But many economists play down the risk.

“You’re worried about the fire sale, the situation where some sales come in and because there’s not enough demand you get more sales and more sales and you have a kind of spiral,” said Donald Kohn, former vice president of the Federal . Reserve’s board of governors and now a senior fellow at the Brookings Institution, a DC-based think tank. “I don’t think anyone sees that right now.”

“But the fact that traders may not have the ability to step in and speed things up is a concern,” he noted.

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

“The reversal in demand was stunning as it was rare,” they added.

Yellen has been focused on the instability in US bond markets since long before the current flare-up, and works to implement new rules aimed at strengthening them. These measures include improving data collection; the need for more oversight of Treasury trading platforms; and expanding the number of eligible dealers to allow more participants in market offerings.

Despite her comments on Thursday that emphasized calm, Yellen appears to be intensifying these efforts amid the latest signs of volatility. Treasury officials asked traders in the market about a possible program to buy back government debt, a potential sign that the US government is worried. The issue was also recently discussed by the Financial Stability Oversight Council, which Yellen chairs, and is expected to come up at its next meeting.

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

But she also sees a compensating trend: As Treasury bond yields rise, more foreign investors are entering 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 economic consultancy Sri-Kumar Global Strategies, also thinks that higher interest rates will make US debt more profitable for investors, bringing more buyers to the market and reducing liquidity concerns.

And more broadly, many economists and financial analysts say concerns about market weakness may be overblown, especially for now, as strong levels of U.S. government bonds – worth about $600 billion – continue to be traded every day.

Historically, warnings about the danger of investors refusing to buy US government debt have not held up. Under the Obama administration, for example, Republicans and other deficit hawks have said that large deficits risk financial collapse if bond buyers lose confidence in the US government. No such crisis occurred.

Sri-Kumar calls those warnings “ridiculous.”

“If I refuse to buy [long-term] bonds, what then? The Treasury will have to offer a higher yield, and we will reach a better equilibrium,” said Sri-Kumar. “This is not Argentina or Zimbabwe or Turkey, where investors said: ‘The interest rates are not enough; keep walking.’ Therefore I think that a strike by the buyers does not make sense.”

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That sentiment was underscored by a senior Treasury official, who told The Washington Post that U.S. policymakers have confidence in U.S. debt markets in part because so many investors around the world seek to buy those bonds. There are countries that are major buyers, including Japan, but even in that case, it is only 4 percent of the total pool.

And while volatility is rising in bond markets, volatility is also hitting the financial sector more broadly – suggesting no specific risk to US bonds despite the importance their greatness, said the Treasury official.

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It has been a different picture recently in Britain, where much of the country’s long-term government debt has been held by pension funds. This made British bonds, or gilts, much more vulnerable to price swings when pension funds moved in unison to dump those assets as their value fell.

This type of contagion is less likely to emerge in the United States, analysts say.

“If you [expect] demand will go higher for higher yielding assets, [this] it makes 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 this… but there is nothing foreseeable on the horizon that is a serious competitor to the US dollar.”

Still, rising bond rates can damage the U.S. economy and government without causing catastrophe. If bond yields must rise to attract investors, capital will flow into government debt – and from more productive uses, such as corporate debt that boosts investment.

“The crisis scenario is a mass sale of those low-yielding bonds all at once. That would be the scenario of a global financial crisis,” said Marc Goldwein, the 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 most likely scenario is that it’s going to cost the U.S. government a lot of money and it’s going to cost a lot of money to the U.S. economy.”

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