Fed’s slowing Treasury purchases may boost yields

NEW YORK — The Federal Reserve’s gradual withdrawal from the US Treasury market as the coronavirus pandemic eases and liquidity improves could dry up appetite for longer-dated government debt and push up long-term interest rates months from now.

The Fed has purchased about $1.3 trillion in Treasuries since an emergency plan kicked off last month to address liquidity issues in the $17-trillion market.

For now, there is no indication that Treasuries have become less popular, with most auctions of US debt being oversubscribed. In an era of negative yields, benchmark 10-year yields between 0.5% and 0.8% still stand out, analysts said.

But the Fed is slowly reducing its purchases, to an average of $15 billion per day last week from a peak of $75 billion per day from March 19 to April 1. Analysts are growing worried there may not be enough demand for Treasuries if the Fed is pulling back.

“If they do withdraw support, it will be the long end that will be under pressure,” said Priya Misra, head of US rates strategy at TD Securities. “People are not getting paid to take on duration risk.”

US Treasury yields raced higher in 2013, an episode in financial markets referred to as a “Taper Tantrum” as the Fed signaled it wanted to slow the pace of asset purchases. The Fed was only able to start shrinking its balance sheet in 2017, nine years after it began expanding it during the global financial crisis.

Treasury has so far issued more than $1 trillion in bills and other types of short-term debt to finance the government’s roughly $3-trillion stimulus package in response to the pandemic’s economic devastation. It has focused on the front end of the curve where there is ample demand from investors fleeing risky assets or trying to raise cash as a liquidity buffer.

But with interest rates at record lows, analysts said it would make sense for the US government, at some point, to issue debt with longer maturities.

Investors are operating on the assumption that the Fed will step in any time and increase their purchases again, analysts said.

“It would be difficult for the Fed to withdraw from the Treasury market,” said Vincent Deluard, global market strategist at INTL FCStone in San Francisco. “In Europe, there are emergency measures that last for 10 years. The funding aspect would be very problematic.”

When the health crisis improves, even if that is before the arrival of treatments or a vaccine, the Fed may be constrained to intervene in the market again, especially with a balance sheet that has ballooned to $6.6 trillion, or about 31% of expected US gross domestic product for 2020.

“I would be careful with longer-dated bonds until I see there are others, other than the Fed willing to buy the increased issuance that the Treasury is putting out there,” said Patrick Leary, chief market strategist and senior trader at Incapital in Chicago. — Reuters