A “dramatic” increase in U.S. bond supply over the next year risks unhinging global markets from their bullish foundations, warns Torsten Slok at Deutsche Bank AG.
The supply of U.S. government debt will almost double to $1 trillion this year to finance a widening budget deficit as the Federal Reserve whittles down its holdings. Unless new buyers emerge, the overhang could be far-reaching.
“If demand for U.S. fixed income doesn’t double over the coming years then U.S. long rates will move higher, credit spreads will widen, the dollar will fall, and stocks will likely go down as foreigners move out of depreciating U.S. assets,” the chief international economist at the German lender wrote in a note Tuesday. “And this could happen even in a situation where U.S. economic fundamentals remain solid.”
Those fears aren’t shared widely on Wall Street, where spreads on corporate bonds have sunk to 2007 lows and bullish indicators abound. The rally in credit appears relentless, retail demand for bonds is insatiable and tax cuts may reduce corporate borrowing.
Commercial banks, emerging-market reserve managers and pension funds are all set to plug the $1.1 trillion hole in global bond demand left by central banks this year, according to JPMorgan Chase & Co.
The US Treasury has a great deal of debt that matures in 2018 as we approach the 10-year anniversary of the global financial crisis. That is at least part of the reason the Federal Reserve is paring its holdings of debt, with plans to roll-off about half of the total maturing this year. Nevertheless, that still represents over $200 billion, in addition to whatever is required to fund the deficit, that needs to be absorbed by the market this year.
US Treasury futures have paused close to the lower side of a more than yearlong range following what has been a very persistent decline since September. Potential for a reversionary rally has increased but a break in the progression of lower rally highs will be required to confirm a return to near-term demand dominance. Medium-term, a sustained move above 125 would be required to question the overall downward bias.