Persistently higher yields at U.S. Treasury auctions are increasing the cost of refinancing debt and funding future deficits, as investors demand greater compensation to absorb Washington’s borrowing needs, raising questions about their appetite to continue buying U.S. debt.
Investors are concerned about the sheer volume of borrowing that must be financed in the years ahead, analysts said. U.S. national debt is approaching a record $40 trillion, according to the Treasury Department, while the fiscal deficit remains large.
“The overall market environment is definitely requiring Treasury to pay more to borrow,” said Zachary Griffiths, head of macro and investment-grade strategy at CreditSights in Charlotte, North Carolina.
“It is more of a problem longer run if we’re going to run budget deficits of 5% to 6% of GDP. Part of that is a fiscal and inflation risk premium, among other things.”
Two Treasury auctions in the past week drew attention for their yields — the sale of 10-year notes cleared at a high yield of 4.683%, the highest in 19 years, while the 30-year bond auction stopped at 5.216%, a 25-year peak.
Still, Treasury demand has held up even as yields have risen to multi-year highs. The same forces driving yields higher — namely inflation concerns, widening fiscal deficits and rising debt supply — are also boosting the compensation investors receive for holding U.S. government debt.
“The appetite for Treasuries is still there and it’s just a matter of — at what yield,” said Jim Barnes, director of fixed income at Bryn Mawr Trust in Berwyn, Pennsylvania. “The 10-year at close to 5% and the 30-year at multi-decade highs will attract more buyers for risk-free Treasuries.”
YIELD CLIMB
Long-term Treasury yields have climbed this year as investors grappled with a combination of heavy borrowing, resilient economic growth, sticky inflation, and uncertainty over the pace of government borrowing.
Investors, therefore, expect that a steady stream of Treasury issuance will compete for capital. Rather than financing a temporary funding gap, the government is increasingly viewed as facing structurally large deficits and borrowing needs.
“We’ve seen a few trends that are worrying us,” said Laureline Renaud-Chatelain, fixed income strategy lead at Pictet Wealth Management, citing the increase in term premium driven in part by high fiscal deficits. The term premium refers to the extra compensation investors demand to hold longer-dated debt.
Renaud-Chatelain said this situation would result in the Treasury continuing to skew its issuance of debt more to the short end of the yield curve.
Growing deficits and higher interest payments have pushed U.S. borrowing needs sharply higher, leading Treasury to increase the issuance of short-term debt that has been absorbed quickly by money market funds.
The recent 30-year bond auction drew particular attention because long-dated Treasuries are especially sensitive to concerns about future inflation, fiscal sustainability and the supply of government debt.
The auction’s outcome reflects “investor caution against long duration,” said Frances Cheung, head of FX and rates strategy at OCBC Bank in Singapore, referring to debt with higher maturities.
The 10-year auction last week sent a similar signal. While the sale attracted solid participation from indirect bidders, a category that includes foreign central banks and institutional investors, the government still had to offer a yield near 4.7% to complete the offering.
NO BUYERS’ STRIKE
Demand remained solid, suggesting investors are not broadly retreating from U.S. debt even as long-term borrowing costs hover near multi-decade highs. A pension fund, insurer or asset manager with a long-term liability may find a 5.3% nominal return on a 30-year risk-free asset compelling.
Alonso Munoz, chief investment officer at Hamilton Capital Partners, also noted that many Treasury buyers are governed by mandates requiring them to hold government debt regardless of opportunities elsewhere.
Foreign demand, however, remains a key focus for investors amid recurring concerns that overseas buyers could become less willing to finance expanding U.S. deficits. Last week’s auction metrics showed no signs of an abrupt pullback.
Analysts noted that U.S. yields remain substantially above those in Japan and many other developed markets, creating an incentive to own Treasuries.
The auction results also did not suggest so-called bond vigilantes, investors who push back against fiscal and inflation risks by demanding higher yields, are actively selling Treasuries, analysts said.
Instead, the sale pointed to a market that remains well functioning but has repriced the cost of financing the federal government.
“Investors demand more to compensate for sticky inflation and large fiscal deficits,” said Ben Bennett, head of investment strategy for Asia at L&G Asset Management in Hong Kong.
(Reporting by Gertrude Chavez-Dreyfuss)
