For bond investors fearing the onset of a bear market, the flood of supply expected this year will only add to their jitters.
A budget deficit that’s set to widen in part due to sweeping tax cuts combined with the gradual wind-down of the Federal Reserve’s balance sheet will lead the Treasury Department to issue $1 trillion of debt in 2018, almost double the amount seen in 2017, according to Deutsche Bank analysts. The estimate is in line with forecasts from others. (See chart below).
In the face of this dramatic unfurling of supply, it’s not clear if bond-buyers have the wherewithal, let alone the appetite, to take down the flood of issuance without seeing yields climb higher.
“If demand for U.S. fixed income doesn’t double over the coming years then U.S. long rates will move higher, credit spreads will widen, the dollar will fall, and stocks will likely go down as foreigners move out of depreciating U.S. assets,” said Torsten Slok, chief international economist for Deutsche Bank, in a note.
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Investors say higher bond yields may upend stocks by presenting a higher ‘hurdle rate.’ That would take the luster off risky assets in the U.S., drawing money away to foreign shores.
Treasurys have already taken a bearish turn at the year’s start. The 10-year Treasury note yield TMUBMUSD10Y, +0.91% broke above 2.50% last week amid growing concerns that global central banks would reverse years of ultraloose monetary policy. Bond prices fall when yields rise.
The Deutsche Bank strategists estimate the actual amount of debt issuance in 2018 will be closer to $1.15 trillion, doubling the $559 billion from last year. The lion’s share will stem from increased sales of government paper with maturities longer than a year.
But $150 billion of this total sum reflects deferred issuance in 2017, when the Treasury Department relied on cash and other measures to finance its needs, instead of borrowing from the market. To replenish its cash balances, the government has had ramp up sales of Treasury bills, which sport maturities of a year or less.
At the November refunding announcement, the Treasury Department said it would lean toward increasing the size of auctions for shorter-dated government paper after consulting with market participants in the Treasury Borrowing Advisory Committee.
Steven Zeng of Deutsche Bank projects bill issuance to more than triple to $447 billion in 2018, from $138 billion in 2017.