Trouble is brewing in the world of U.S. Treasury bonds, prompting concern among investors and some Washington policymakers.
For now, no one is panicking. But the market for U.S. Treasury bonds has lately displayed a level of volatility not seen since the beginning of the pandemic-related crisis in 2020, when the Federal Reserve cut interest rates to zero and went on to buy $1 trillion of treasuries and other financial assets to keep the global financial system functioning.
Top government officials have in recent weeks acknowledged that dysfunction in U.S. government bond markets risks triggering a spike in the federal government’s borrowing costs and a wider upheaval in financial markets. They are beginning to take preventive steps.
“We have been looking very carefully at the Treasury market,” Treasury Secretary Janet L. Yellen told The Washington Post on Thursday, stressing that the market has continued to function normally. “It’s, of course, critical that it continue to function well.”
The Treasury Department auctions bonds to pay for government operations, effectively borrowing money from investors in return for a guarantee of repayment with interest. These bonds are crucial for a healthy financial system, because other, riskier assets — stocks and corporate bonds — are priced in relation to the cost of Treasurys.
But as central banks such as the Federal Reserve engage in one of the biggest interest-rate-hike campaigns in decades, demand for U.S. government bonds already in circulation has fallen in part because most of that debt carries lower interest rates than the bonds being issued today. That could mean a glut of cheap, low-yielding debt with few buyers.
There’s been no emergency thus far, but the market for Treasury bonds is drawing increased attention out of concern that as liquidity dries up across the globe, there may at some point not be enough buyers of debt issued by the U.S. government. With prices falling, yields on 10-year Treasury bonds have already risen from less than 1.5 percent to roughly 3.8 percent this year. (Bond prices and bond yields move in opposite directions.)
A dearth of buyers could cause a ripple effect by forcing down the price of bonds, some economists and analysts warn. A panicked sell-off of U.S. Treasurys could wreak havoc on markets — giving investors leverage to demand higher returns, or yield, on their bond purchases. That would mean higher prices for all kinds of financial instruments pegged to those rates. It would also drive up the cost to the government of financing its debt.
“If we were to have a buyers’ strike, or a failed series of Treasury auctions, interest rate increases could accelerate — and all of a sudden, the financing of debt with credit cards, auto purchases, [and] housing purchases would rise in cost,” said Joe Brusuelas, the chief economist at the management consultancy RSM. “That could drive down living standards for Americans, and you could find yourself with a very difficult problem for your economy.”
Experts have raised other concerns as well. New regulations enacted after the 2008 financial crisis have discouraged banks from acting as intermediaries by requiring them to hold more capital to cover potential losses on government securities. In addition, the Federal Reserve and other central banks are either selling Treasurys or just no longer reinvesting them, as part of their attempts to cool the economy and fight inflation, removing one backstop purchaser of U.S. bonds.
And the recent panic in Britain over its own government debt — which recently fell dramatically in value, leading to an intervention by the Bank of England — has further amplified concerns that a similar market panic could occur here. But most economists downplay the risk.
“You’re worried about the fire sale, the situation where some selling comes in and because there’s not enough demand you have more selling and more selling and you get kind of a spiral,” said Donald Kohn, a former vice chair of the Federal Reserve’s board of governors and now a senior fellow at the Brookings Institution, a D.C.-based think tank. “I don’t think anyone sees that right now.”
“But the fact that the dealers may not have the capacity to step in and smooth things out is a worry,” he noted.
Analysts at JPMorgan Chase expressed similar worries in a report this month, citing a lack of “structural demand.”
“The reversal in demand has been stunning as it has been rare,” they added.
Yellen has been focused on instability in U.S. bond markets since well before the current flare-up, working to implement new rules aimed at shoring them up. These measures include improving data collection; requiring more oversight of Treasury-trading platforms; and expanding the number of eligible dealers to allow more entrants into market bidding.
Despite her comments Thursday emphasizing calm, Yellen appears to be intensifying these efforts amid the latest signs of volatility. Treasury officials have asked traders in the market about a possible program to buy back government debt, a potential sign the U.S. government is worried. The matter also was recently discussed by the Financial Stability Oversight Council, which Yellen chairs, and is expected to come up at its next meeting.
A key concern for Yellen, as she relayed to Bloomberg News this month, is the potential for “a loss of adequate liquidity in the market.”
But she also sees a countervailing trend: As the payouts on Treasury bonds rise, more foreign investors are stepping into the market to absorb excess capacity.
“You asked who is going to buy Treasurys, and I think part of the answer is they have very attractive yields,” Yellen said Thursday.
Komal Sri-Kumar, the president of the economic consultancy Sri-Kumar Global Strategies, also thinks higher interest rates will make U.S. debt more lucrative to investors, pulling more buyers into the market and easing concerns about liquidity.
And more broadly, many economists and financial analysts say concerns about market weakness may be overblown, especially for now, as healthy levels of U.S. government bonds — roughly $600 billion worth — continue to be traded every day.
Historically speaking, warnings about the danger of investors refusing to buy U.S. government debt have not held up. Under the Obama administration, for example, Republicans and other deficit hawks said that large deficits would risk a financial meltdown should bond purchasers lose faith in the U.S. government. No such crisis materialized.
Sri-Kumar calls those warnings “a ridiculous thing.”
“If I refuse to buy [long-term] bonds, what happens then? The Treasury will have to offer a higher yield, and we reach a better equilibrium,” Sri-Kumar said. “This is not Argentina or Zimbabwe or Turkey, where investors have said: ‘Interest rates are insufficient; keep hiking.’ That’s why I think a buyers’ strike does not make sense.”
That sentiment was stressed by a senior Treasury official, who told The Washington Post that American policymakers have confidence in the U.S. debt markets in part because so many investors worldwide seek to purchase those bonds. There are countries that are major buyers, among them Japan, but even in that case, it is just 4 percent of the total pool.
And while volatility is up in the bond markets, volatility also is hitting the financial sector more broadly — suggesting no specific risk to U.S. bonds despite their outsize importance, the Treasury official said.
It was a different picture recently in Britain, where much of the country’s long-term government debt has been held by pension funds. That made British bonds, or gilts, much more vulnerable to price swings when the pension funds moved in unison to shed those assets as their value fell.
That kind of contagion is less likely to emerge in the United States, analysts say.
“If you [expect] demand will go higher for a higher-yielding asset, [this] would make the fear kind of silly or misplaced,” said Bob Hockett, a former Fed official and public policy expert now at Cornell University. “I don’t want to be complacent about this … but there’s nothing foreseeable on the horizon that’s a serious competitor to the U.S. dollar.”
Still, rising bond rates can harm the U.S. economy and government without causing a catastrophe. If bond yields have to spike to lure investors, capital will flow into government debt — and out of more productive uses, such as the corporate debt that fuels investment.
“The crisis scenario is a mass sell-off of those low-yielding bonds at once. That would be the scenario of a global financial crisis,” said Marc Goldwein, the senior vice president for policy at the Committee for a Responsible Federal Budget, a D.C.-based think tank. “But I think that’s unlikely. … The more likely scenario is it will be very costly to the U.S. government and very costly to the U.S. economy.”