2024-08-28 10:00:57
By Mike Dolan
LONDON (Reuters) – The U.S. Treasury will issue a slew of bonds next year but its active management of its maturing bond profile suggests an oft-predicted U.S. debt “crisis” is unlikely to happen any time soon.
The fiscal financing math is pretty tough right now, with more than $500 billion in notes and bonds being auctioned this week alone.
But almost three-quarters of this week’s massive debt was short-term Treasury bills with maturities of 12 months or less, which will be rolled over at gradually lower rates if U.S. interest rates fall as expected.
While the huge weekly Treasury sales are well known, many investors are still circulating the notes, expressing concerns about the growing level of government debt that needs to find willing buyers.
Torsten Slok, chief economist at Apollo Global Management (NYSE: Apollo Global Management), is the latest to warn of potential dangers ahead, with a list of “top 10” Treasury facts.
Slok pointed out that $9 trillion of government debt will mature in the next year, the cost of debt repayment has reached 12% of government spending, a trillion-dollar deficit is expected in the next decade, and the debt/GDP ratio is expected to double to 200% by the middle of this century.
His conclusion is simple: Be wary of auction volatility, possible credit downgrades and the ongoing threat that long-term bond investors will begin demanding a huge “term premium” to hold long-term Treasuries.
But by pre-setting debt maturities, the Treasury is revealing one of its main tools for circumventing a debt crunch over the next year or more.
While the weighted average maturity of the entire stock of marketable debt remains above pre-pandemic levels, close to six years, bonds maturing in a year or less account for 22% of the total – well above the 10%-15% seen 18 months ago and well above normal levels for much of the decade before the pandemic.
With policy rates currently above 5%, issuing bonds in the short term will be costly.
But the situation would change dramatically if the Fed went into rate-cutting mode next month and lowered rates by more than 200 basis points over the next year, as futures markets currently expect.
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Does this mean that the Treasury is intentionally distorting the U.S. government bond market? CrossBorder Capital analysts believe that the Treasury is doing just that through its “active duration management” (ADM) policy, which is designed to keep yields down.
In an article titled “The U.S. Treasury Bribes the World’s Smartest Investors,” CrossBorder simulated what this note-intensive maturity scenario would mean for debt maturities that currently receive less attention, such as the benchmark 10-year U.S. Treasury note.
Analysts compared the latter’s yields with those of equivalent mortgage-related bonds in the U.S. (which are much higher), adjusting for interest rate sensitivity and associated “convexity”.
Their models show a gap of more than 100 basis points between the two, which they attribute entirely to this unofficial ADM policy.
CrossBorder says a financing haircut of that magnitude would reduce the U.S. debt-to-GDP ratio forecast for 2050 by a full 35 percentage points.
So is it a win-win situation? Maybe not entirely.
The negative impacts are less obvious, but no less significant.
If the 10-year yield is suppressed to this degree, then this is one of the reasons why the yield curve shape has remained inverted for more than two years without the recession that many people were talking about actually happening.
But losing such a useful tool for predicting future economic and inflation trends comes at a cost.
Moreover, the average maturity of the entire debt stock shortens further from now on, making rollover risk even more worrisome. If short-term paper risk continues to rise, cyclical “surprises” such as the debt ceiling dispute or the threat of temporary defaults in the short-term paper market could have a disproportionate impact.
While continuing to flood the bill market with new bills may reduce debt service costs in the short term, what happens when the Fed cycle turns again or the economy truly enters a new phase of persistently higher inflation and interest rates?
This risk is particularly acute given current political realities. Without a shift in fiscal policy in the coming years, the U.S. debt situation will eventually require some painful adjustments.
And, ironically, the lack of market turmoil during the transition may actually reduce the chances of political action to control deficits and debt, which would only compound the problem.
But it is also clear that government debt managers have a range of tools and instruments to help them navigate the current period and avoid triggering the kind of crisis that many predict.
Whether these moves are anything more than stopgap measures is another matter. But given recent history, it seems dangerous to bet that the Treasury and the Fed can’t continue this particular farce for the foreseeable future.
The opinions expressed in this article are those of the author, a columnist for Reuters.
(Written by Mike Dolan; Edited by Paul Simao)
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