The yield on the 10-year US bond today is the same as it was before Lehman Brothers broke out in the subprime financial crisis. Therefore, the cost of borrowing at that term for the American Federal Treasury also according to that reference. Only now the burden of public debt has tripled (from 10 to more than 33 billion dollars) and with it the interest payment associated with these issues is on its way to one billion dollars annually after doubling in just 18 months.
According to data at the close of Wall Street, the interest rate on the US 10-year debt rose to 4.5%, its highest level since June 2007, due to bond sales and the fall in price, which It moves inversely to performance. So why are investors selling? The answer seems easy a priori. Even greater returns on new debt issues await after the Federal Reserve (Fed) meeting and the explanations given by Jerome Powell.
Also because they are jumping to another shorter term that offers them even greater attractiveness. The T-bills (bills) at 3.6 and 12 months ‘pay’ around 5.5%, while the ‘treasuries’ at 2 years pay 5.15%, 4.86% at 3 years or 4.6% at 5 years. The 10-year bond, the long-term financing reference for a country, still maintains the curve inverted in an anomalous way (shorter term, higher yield) but it may not be for long, according to some investors.
The first reason must be found in the Fed’s signal about a possible additional interest rate increase before the end of 2023 and the pouring of cold water on expectations of rate cuts in 2024. The second emerges from the new macro projections of the central bank after the drastic improvement in economic growth expected in 2023 from the 1% estimated in June to 2.1% now, in addition to the increase of four tenths, to 1.5%, in the pace of GDP for 2024. It is confirmation that, officially For the Fed, there is neither a recession nor is it expected.
“Investors have been discounting interest rates well below those that finally occurred for a long time, and a quick return to ‘normality’ as soon as the outbreak of inflation subsides. It does not seem that the second could be as fast as they would have liked, without “several structural factors suggest that both inflation and interest rates will be, on average, higher for many years than the levels we have seen in the last decade,” they point out in Creand AM.
There are those who see a change in trend. “The 10-year Treasury yield still has room to rise, although the 2-year seems fine as is. The Fed will be glad the market is paying attention to its more hawkish stance. Another rate hike was left on the table, since the Fed is still in the process of finding ‘the appropriate level of restriction’ to bring inflation to the target, but – as he said – it is “pretty close to where it needs to be,” they point out in a statement. report from the Dutch firm ING Research.
“The big picture for the next two years is for Fed rates to be much lower than they are today. That doesn’t need to be matched by a 2-year bond much above 5%. In fact, this is one part of the curve that may fall further once the Fed is confirmed to have peaked. In short, there is likely momentum for the curve to steepen (no longer be inverted) in the coming weeks,” say Benjamin Schroeder and Padhraic Garvey, economist at Orange Bank.
The end of the inverted curve?
The rise in debt yields this week has had a greater echo in long-term debt compared to short-term debt, which moved in line with the Fed’s official rates. Fear of an economic recession led to the bonds (2 years vs 10 years) to be listed upside down in June 2022, but the feared contraction has not occurred. On the contrary, the central thesis of the Fed continues to be a controlled landing and takeoff of the economy without traumas. “I’ve always thought that the soft landing was a plausible outcome, that there really was a path to a soft landing. I’ve thought that and I’ve said that since we started the rate hike process,” Powell said Wednesday at the press conference. .
In the opinion of the Fed’s chief governor, the increase in debt rates is not only due to inflation but also to expectations of economic improvement and the expectation that there will be no rate cuts in the short term. There is a latent factor that is being quoted in the bonds and it is the process of reducing the balance of the central bank, which continues to amortize the debt portfolio and sell some assets.
“Also a greater supply of Treasury bonds,” Powell assured in reference to the increase in the Biden Government’s debt placements to finance itself. The situation is not trivial since the increase in US public debt has quickly surpassed 33 trillion dollars just three months after the debt ceiling of 32.5 trillion was suspended – to raise it.
The speed of the increase is around $6 billion a day and will increase as the Treasury refinances at current rates above 5% after having enjoyed 0% financing during the pandemic. In just over 18 months, the cost of the US’s annual debt will have doubled from just under $500 billion to nearly $1 trillion.
The fight between Democrats and Republicans is once again on the front line but this time due to the budget blockade that could lead to the closure of the federal Administration and all agencies dependent on Washington. It is what the law states. If it occurs, uncertainty can add tension to the debt markets but at the same time it will mean short-term savings in the Government’s financing needs since it will stop paying civil servants while it lasts, although it will reimburse them what is owed once it reopens. . the administration.