U.S. government bonds are taking investors on an unusually gentle ride. Even as short-term interest rates have spiked over the past two years, yields on longer-dated government debt have remained lower. It’s a rare occurrence that is at odds with financial history and with the current economic trajectory of the United States.
The exterior of the Marriner S. Eccles Federal Reserve Board Building is seen in Washington, D.C., U.S., June 14, 2022. REUTERS/Sarah Silbiger/File Photo - RC2QRU97D3PDLONDON, April 16 - When the bond rollercoaster returns, fund managers and Uncle Sam will be in for a shock.
Yet holders of U.S. government debt are currently in the opposite position. Since July 2022, the yield on three-month Treasury bonds has been higher than the return on 10-year debt. In other words, the yield curve is sloping downwards. Such an inversion is rare: since 1959, there have only been five other occasions where it has occurred for more than 50 consecutive days, according to U.S. Federal Reserve data. What’s more, the current period of inversion – at 93 weeks and counting – is a record.
An alternative theory is that bondholders think the central bank will tolerate rising prices rather than inflict the economic pain of higher rates. But that would clash with the Fed’s mantra that departing from its 2% inflation target would destroy its credibility and risk unleashing an uncontrollable price spiral. Besides, higher inflation undermines the value of fixed-income securities.
Two other factors will also contribute to higher long-term yields. The first is that the Fed, which bought bonds worth around $9 trillion during the past 15 years, is now shrinking its securities portfolio. And second is that the federal government in Washington will be issuing a lot of debt to finance budget deficits that the International Monetary Fund reckons will average 7% of GDP a year until 2028 – more than double the level a decade ago.
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