Persistently high inflation, the Federal Reserve's tightening policy and record-breaking US debt have wreaked havoc on US Treasuries this year.
Now, economists are noting a fundamental and worrisome imbalance in the bond market. There are trillions and trillions of dollars worth of bonds for sale, they say, but a growing scarcity of buyers. If this trend persists, it could lead to credit problems and inhibit the US government's ability to fund itself. That's particularly concerning after America's national debt climbed north of $31 trillion for the first time on Monday.
What's happening: US bond prices have rallied alongside equities this week as investors, spurred on by a loosening labor market, bet that the Federal Reserve could ease its aggressive rate hike policy earlier than expected. The upward swing brought some temporary relief to the bond market, which is in the midst of a historically awful year.
But that relief may be short-lived. The US Treasury — backed by the US government and considered the safest of bonds — is experiencing what JPMorgan analysts describe as a "structural absence of demand."
JPMorgan strategists, led by Jay Barry and Srini Ramaswamy, write that the three main buyers of US government debt — the Federal Reserve, commercial banks and foreign governments — have significantly eased up on their purchases.
Using Federal Reserve data, they found that commercial banks' collective holdings have fallen by $60 billion over the last six months compared to the same period last year, after growing by more than $700 billion between 2020 and 2021. Foreign governments' official holdings have dropped $50 billion over the past six months.
The Federal Reserve, meanwhile, has dropped its Treasury holdings by about $180 billion so far this year as a part of its monetary tightening program to fight inflation and cool the economy.
The move by the Fed was expected. At the onset of the Covid-19 pandemic, growth slowed and the Fed began purchasing $120 billion in government backed bonds each month as a way to inject money into the economy. Now, the central bank has reversed course.
Still, overall, the drop in demand for Treasuries is extraordinary.
"The reversal in demand has been stunning as it has been rare for demand from each of these three investor types to all be negative at the same time," wrote Barry and Ramaswamy.
What's next: Investors will pay close attention to unemployment numbers out this Friday. If unemployment grows, it could signal the Fed will ease on its rate hikes. That's good news for the bond market. If unemployment continues to remain low, the retreat from Treasuries could continue.
As bond prices tumble, yields rise, raising the cost of borrowing for the government.
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