Oscar Wilde had it down pat: a cynic is someone who knows the price of everything and value of nothing. The world’s most watched price, what it costs to borrow money, serves as a reminder of Wilde’s wit every now and then.
This week, eyes were drawn to the land of easy capital, the US, as its federal government’s debt leapt past $40 trillion, bonds issued by it saw yields rise (on a sell-off) and its Treasury department said it would double buybacks of its long-dated paper.
Since these T-bonds are ‘risk-free’ assets and their yields set the floor for interest charges on risk-laden long loans—like home mortgages—their rise signals costlier credit.
Bulk-buying US paper to raise their market prices is a way to calm yields down (as a higher price implies a lower yield). The 30-year Treasury bond’s yield had risen above 5.3%, its highest since 2007, before it eased to 5.2% on news of the plan.
Yet, even if the department snaps up $32 billion worth of T-bonds every quarter, as expected, it may not be able to move the needle much in a market for investor-held paper whose face value adds up to about 1,000 times that sum.
Why did demand for US debt slump? After all, America issues the world’s reserve currency, the dollar, its bonds are deemed free of default risk, and so long as others need dollars for trade, they require large stashes of today’s ‘gold’—T-bonds. But then, their market appeal as assets is shaped by economic trends.
While printing dollars does grant America special leeway to run yawning fiscal deficits, how much debt it can pile up safely is a known unknown of the global T-bond market. At almost 6% of GDP already, the federal gap between revenues and outgoes could widen if the US bumps up its military outlay.
What may also worry investors is the threat of inflation being more than a blip. If the US Fed’s promise of price stability were to wobble, investors would demand higher T-bond yields just to protect their real returns. Gulf War III has yielded an inflationary oil choke shrouded in a haze of dust, even as Fed policy has gotten harder to forecast.
Of course, sovereign yields have hardened in many other economies too, with Japan’s bonds ‘in play,’ but traders seem most acutely focused on America, where large offers of private paper by Big AI players (among others) have lately fed an upswell of overall bond supply.
That bond prices fall (thereby raising their payback yield) if their supply outweighs demand (and vice-versa) is a market rule. It rhymes with the classic proposition that an economy’s basic rate of interest moves up and down to keep overall investment and savings in balance.
Keynes drew ‘liquidity preference’ into this frame of theory: while that rate is set by the demand and supply of money, we prefer money at hand—for buying stuff, future bets and as a crisis cushion—and interest payments are the reward for parting with it. An irony lies in how aloof all this sounds from debt markets.
At most, such market forces are spotted in studies of an economy’s ‘neutral’ rate of interest. What prevails in the near-term is policy, neutral or not. After all, for optimal macro outcomes, a central bank must regulate short-term rates, whether to fan GDP expansion or cool prices lest the economy overheats.
Since 2008, the US Fed has sought to shape longer-term rates too. Yet, the T-bond yield curve isn’t easy to bend. And since investors do exist who value policy reliability, it might get harder still.