Who’ll buy all the Treasuries? You’ll buy all the Treasuries

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Barclays’s annual Equity Gilt Study dropped on Tuesday. Equities and gilts barely get a mention. What Anshul Pradhan and his co-authors really really want to talk about are US Treasury bonds. Specifically, they want to talk about the forthcoming ‘Treasury tsunami’ and what it might mean for . . . well, everything. 

To be fair, the Treasury market is the most important capital market in the world. And supply is projected to be pretty huge over the next few decades. In fact, the Congressional Budget Office forecasts that government debt-to-GDP is on an explosively upward path:

But, according to Barclays:

While these projections are alarming, in our view they are actually quite rosy

This is because the CBO assumes Trump-era tax cuts expire, discretionary spending – including on defence – continues to fall, and the Fed cuts rates a lot. Barclays aren’t so sure.

Furthermore, until recently, the Treasury market has been swamped with large price-insensitive buyers in the form of the Fed (👋 SOMA) and foreign central banks (👋 SAFE):

But with QE giving way to QT, and foreign central banks no longer swallowing between half and all of net issuance, other buyers (mostly households) will need to step up. And, Barclays reckons, they might want to get paid.

So, how much?

Like all good macro analysts, Barclays start with R-star – an unobservable, some might say mystical, neutral rate of interest around which central banks set policy. For ages, bond yields were low and guesstimates of R-star were low. Gertjan Vlieghe argued when he was on the Bank of England’s Monetary Policy Committee in 2016 and again in 2021 that R-star would stay low because of the three Ds: debt, demographics, and the distribution of income.

Now that bond yields are higher, those guesstimates are higher. This, Barclays argue, is due to what we’re going to call the three new Ds: debt, demographics, and decarbonisation. They don’t dwell on the commonality of Ds deployed in yesteryear in arguing for a low R-star. And neither will we.

Whack an inflation rate of 2–2.5 per cent onto their neutral real rate guess and you can understand why they think the neutral fed funds rate might land in the 3.5–4 per cent region. But fed funds are just one point on the yield curve. What about ten-year Treasury yields?

As bond geeks will recall, there are many competing ways to calculate term premia in theory. And Barclays reckon that some mix of the incipient supply glut, higher rate volatility, greater risk of Trumpian fiscal dominance, and becoming a frankly useless hedge to risky assets all might push term premium higher.

Regressions, modeling and some teeth-sucking result in their guess that term premia should put ten-year Treasuries yielding around 100bps over fed funds. So with Fed funds at 3.5-4 per cent, the ten-year would trade at maybe 4.5-5 per cent. 100bps happens to be bang-on the historical average pick-up over fed funds outside periods at which fed funds was below 1 per cent. It also happens to be where ten-year Treasuries are trading right now, though perhaps not when the analyst put digits to keyboard.

Having found this 4.5 per cent to 5 per cent answer, much of the rest of the report is devoted to thinking about what this might mean for everything else.

The short answer is: nothing good.

As far as other developed bond markets go, native English speakers feeling they are in charge of their own destiny should look away now:

While it feels intuitive, it is still a big deal. Monetary policymakers around the world nudge short term interest rates higher or lower to influence domestic growth and inflation. But (italics Barclays’):

if the increase in yields in other geographies because of the rise in UST yields is inconsistent with what is warranted by domestic growth, inflation and policy, then it represents an imported tightening in financing conditions. … if a central bank’s subjective judgement suggests that the scale of these bearish spillovers and the subsequent tightening in financing conditions is challenging the profile for its policy targets at home, then a policy response—rhetoric or action—might be deemed necessary.

Translation: US fiscal incontinence will drive Treasury yields higher and tighten monetary conditions around the world. A case of our bond market, your problem.

Christine Lagarde spoke about this ‘external tightening’ at an ECB presser last year. Barclays argue that it’s coming to Japan, and is increasingly a feature of life for policymakers in the UK, Australia and Canada. And, of course, US monetary policy and wiggles in the Treasury market have been in the blood of emerging market central banking for pretty much ever.

What does this mean for everything else? We’ll switch back to table format:

People have been worrying for decades about what mounting government debt and gaping budget deficits might mean for bond term yields. Hedge funds have lost their shirts time and again betting that sUrEly yIELds mUSt RisE. Now yields are higher. Debt is higher. And budget deficits don’t look like they’re about to narrow. As Alex explained in a post a few weeks back, Treasury auctions are structured so they can’t actually fail, but that’s not to say that yields won’t rise on a ‘tsunami’ of supply. So maybe this time is different? 

Or maybe, given that ten-year Treasury yields are bang in the middle of the expected range, Barclays have just provided a reasonable articulation as to how we got where we are, with the future still a mystery.

Let us know what you think!