LONDON (Reuters) – One of the highest U.S. inflation rates in decades has drawn a muffled yawn in bond markets, making it harder to see what – unless there is a dramatic and unlikely revision of the central bank – could move long-term lending rates much more.
An obvious reason for the relative stasis is the $ 80 billion per month in Treasury debt purchases by the Federal Reserve. But that’s not the only factor.
Overseas demand for US Treasuries is booming as new sales of long-term debt are expected to decline. Such a tight supply is counterintuitive given the currently dazzling government spending and may help explain what looks like shady math in the market.
Unadjusted for inflation, the US economy grew more than 10% on an annualized basis in the first quarter. This week’s figures showed inflation topped 4% for the first time in more than a decade, with a “base” rate excluding food and energy prices at an annual rate of 3% for the first time since the mid-1990s.
But 10-year Treasury lending rates are only 1.7% – where they were before the COVID-19 shock last year, and falling even from April despite the inflationary surprise and a auction of $ 41 billion on Wednesday.
Of course, the Fed and the White House quickly ended any speculation on higher interest rates by reaffirming their view that the rise in inflation was “transient” and mainly due to bottlenecks. strangulation related to the pandemic and base effects that will subside as lockdowns end and activity normalizes. .
Many investors agree.
Bond fund manager Andrew Mulliner at Janus Henderson estimates that inflation prices in bond markets – where five- and ten-year inflation expectations are around 2.7% and 2.5% – are “ more and more excessive ”.
“For now, we see higher bond yields as an opportunity to add exposure to our funds and ultimately we expect inflation expectations to decline from their current high levels. “, did he declare.
But there are other dynamics beyond the point of view of inflation.
Stephen Jen and Joana Friere of hedge fund Eurizon SLJ say purchases of quantitative easing bonds by central banks around the world will keep US bond calculations “distorted” relative to growth and inflation.
In a recent memo, they said the traditional correlation between US nominal growth and T-bill yields has been deliberately dismantled by QE over the past 12 years, describing the policy as a “positive supply shock.” for bonds, stocks and economic production.
“US bond yields, like those of most other countries around the world, no longer contain useful and reliable information on the economic outlook,” Jen and Friere wrote, adding that investors were over-interpreting bond market movements despite this. “Repression” in progress.
‘FREE FLOAT’ WITHDRAWAL
Their key point is that the magnitude of bond purchases by the European Central Bank, Bank of Japan and Bank of England relative to the underlying budget deficits – 161%, 110% and 129% respectively – means that the three actually suck more out of the market. that their governments sell.
This reduces the amount available for private investors who need safe assets in the world’s major reserve currencies.
As the equivalent purchase ratio for the Fed is much lower – now only 37% of US deficits – the 10-year impact has been to almost double the share of Treasuries in the global free-float bond indices of the four main reserve currencies at 60%.
That, combined with rising index funds and retiree demographics, means private sector demand for US Treasuries from home and abroad has more than made up for the blockage in central bank demand. from China and other countries during the decade.
Overseas central banks have increased their holdings of treasury bills by $ 500 billion since 2011, while domestic and foreign private investors have increased theirs by some $ 10.5 trillion.
“Demand for US Treasuries from global savers will remain very strong due to a shortage of safe haven sovereign bonds due to massive QE operations,” Jen and Friere wrote, making it more likely that yields will remain abnormally low relative to growth and inflation. .
And that’s just the demand side of the equation.
HSBC U.S. rates strategist Lawrence Dyer sees the 10-year Treasury yield at just 1.0% by year-end – a forecast he says is based on supply dynamics and a projected decline in the US budget deficit to 5% by fiscal 2023 from a whopping 15% now.
Dyer believes that past sales of long-term debt securities will be reversed as funding requirements decline. He expects a 25% drop in auction volumes for seven- to 30-year bonds, which have doubled since the pandemic shock, with long-term issuance reduced and then evenly distributed between bonds and notes. five years and under.
“This year could mark a peak in bond supply as the deficit is expected to narrow significantly,” Dyer said.
All of this pushes back fears that post-pandemic inflation fears could trigger a bond rout which, in turn, spawns drops in all interest-sensitive or long-lived assets, from tech stocks to credit and to emerging markets.
The Fed could, of course, still turn this around by signaling an anticipated decline. But without such an imminent move, the bond market could stay at these levels much longer.
The author is editor-in-chief for finance and markets at Reuters News. All opinions expressed here are his.
by Mike Dolan, Twitter: @reutersMikeD; Graphics by Stephen Culp and Reuters Graphics; Edited by Catherine Evans