WITH THE US about to sell the most debt in eight years, Treasury Secretary Steven Mnuchin may find himself relying on a buyer base that needs to see higher yields before loading up.
Government debt sales are set to more than double in 2018, lifting net issuance to $1.3 trillion, the most since 2010, according to JPMorgan Chase & Co. estimates. With the Federal Reserve shrinking its bond holdings and deficits poised to swell even before taking into account the tax overhaul, all signs point to higher financing costs.
The challenge for Mnuchin is that some analysts predict buying by central banks — a pillar of support this year — may fade, in part as international-reserve growth stabilizes. In the view of Credit Suisse Group AG, that will put the onus on more price-sensitive buyers, particularly a group that the Fed classifies as including households, hedge funds, private-equity firms and trusts for wealthy individuals.
“The household sector will have to absorb a significant fraction of new supply,” said Praveen Korapaty, Credit Suisse’s head of global interest-rate strategy. “These guys are asset managers and hedge funds and even households, with a lot of them price-sensitive. They will buy at certain levels, and if yields are low they will maybe not be as interested. That argues for higher yields.”
The household category held $1.345 trillion of Treasuries as of September, down from $1.409 trillion at the end of last year, Fed data show. That decline came as 10-year yields fell last quarter to the lowest levels of 2017.
By Credit Suisse’s calculation, with the Fed pulling back and issuance surging, the slice of debt sales available for price-elastic buyers to absorb will rise to about 60% by the end of 2019, from 54% now. It would be their biggest share since the early 2000s.
The Treasury said last month that it expects to unveil bigger coupon auctions in February for the first time since 2009, and dealers see issuance rising for years to come. With entitlement costs heading higher, the US debt burden was already projected to increase by $10 trillion in the next decade. Now the tax overhaul could boost the deficit by $1 trillion in the period.
JPMorgan’s 2018 net issuance tally of $1.3 trillion includes $847 billion of coupon debt, ballooning from an estimated $409 billion this year amid a darkening fiscal backdrop. The federal deficit may exceed $1 trillion by fiscal 2020, from about $666 billion in 2017, according to the most dire estimates by primary dealers. Meanwhile, the Fed could roll off about $250 billion of Treasuries in 2018.
The catch is that demand from China, which with almost $1.2 trillion of US government debt is America’s biggest foreign creditor, may be about to ebb. The bulk of China’s buildup came as it boosted foreign-exchange reserves to help offset a strengthening yuan. But some forecasters see yuan stability in 2018, meaning limited need for currency intervention.
It’s not just the household sector that would need to step up should China back away.
Pension funds, which held about $2.3 trillion of Treasuries as of September, are set to add more in 2018 as they shift their focus from equities and corporate debt given stretched valuations, Societe Generale strategists predict.
The net purchases by pensions, along with insurance companies and state and local-government retirement funds, should rise to $110 billion in 2018, versus $90 billion this year, JPMorgan forecasts.
Private and public pensions’ holdings increased in the third quarter by $266 billion after falling in the first half of the year, Fed data show.
“The defined-benefit pension plans are going to be buying a lot more long-term Treasuries,” said Guy Haselmann, a managing director at OpenDoor Trading LLC, a Treasuries trading platform. Private pensions are trying to avoid penalties related to being underfunded, he said.
Many analysts see pensions and their quest to add duration as having helped fuel this year’s dominant bond-market phenomenon — the relentless flattening of the yield curve. Their demand is also evident in the surging amount of notes and bonds split into principal- and interest-only securities, known as Strips.
US banks, which are on pace to lighten up on Treasuries in 2017 for the first time in four years, should increase holdings next year by roughly $150 billion, Credit Suisse forecasts.
That’s partially due to the fact that the Fed’s tapering will reduce bank reserves, pushing these firms to buy more Treasuries to replenish holdings of high-quality liquid assets.
The wave of supply and the questions about demand come amid expectations for higher yields with the prospect of quicker US growth and inflation.
The Fed projects three more rate hikes in 2018, and firms including Goldman Sachs Group Inc. predict 10-year yields will rise to 3% in a year, from 2.46% now.
“There should be some overall repricing of yields higher, albeit modestly, on the back of the rising supply picture,” said Subadra Rajappa, head of US rates strategy at Societe Generale. “The amount of the supply increase will be quite large, and it’s not clear how much support is going to come from overseas.’’ — Bloomberg