The International Monetary Fund warned Wednesday that the relentless US debt issuance is undermining the premium Treasuries have commanded from investors, with implications for government securities across the globe.
“The increase in the US Treasury security supply is compressing the safety premium that US Treasuries have traditionally commanded — an erosion that pushes up borrowing costs globally,” the Washington-based IMF said in its latest Fiscal Monitor report.
The US has been selling large volumes of debt because its budget deficit has averaged roughly 6% of gross domestic product over the past three years, an unprecedented shortfall outside of wartime or recession eras. The gap is expected to stay around those levels throughout the coming decade, according to the Congressional Budget Office. In reality, it will only get wider.
As Bloomberg reports, the IMF pointed to a narrowing gap between the yields of AAA rated corporate bonds and Treasuries as a sign of reduced appeal for US government securities. While spreads have typically been viewed as a gauge of the risk investors estimate for corporate borrowers, the fund is flipping that analysis on its head to view it as a metric of how much extra buyers are willing to pay for Treasuries.
“A narrowing spread implies that the premium investors pay for the safety and liquidity of Treasuries (relative to high-grade corporate debt) is compressing,” the IMF said. The fund showed that AAA corporate spreads have shrunk to roughly 35 basis points from more than 55 basis points at the start of 2019.
Besides funding runaway US debt, another danger flagged by the IMF was the increasing reliance of the US Treasury on sales of short-dated debt, a process launched by Janet Yellen and her Activist Treasury Issuance, and maintained ever since. Having initially criticized the Bill buildout, Treasury Secretary Scott Bessent last year said that it didn’t make sense to expand issuance of longer-dated securities, given that their yield levels were above those of T-Bills, which mature in under a year.
“When debt is concentrated at shorter maturities, governments must refinance more frequently, increasing their exposure to abrupt shifts in market conditions or investor sentiment,” the fund said, noting that the US – along with all other “developed” governments – has shifted reliance toward sales of bills.
Wednesday’s warnings come three weeks before Bessent’s Treasury sets out its latest plan for US debt issuance, known as the quarterly refunding policy statement.
Finally, the IMF also flagged the increasing role that hedge funds are playing in the Treasuries market, via so-called cash-futures basis trades, as a risk.
“The liquidity that hedge funds supply through such trades can be prone to flight, as it is backed by more-leveraged investors: a spike in volatility or financing costs can trigger forced unwinding, amplifying price dislocations,” it said.
Multiple elements – historically high borrowing needs, the composition of demand for Treasuries tilting toward hedge funds and the increasing reliance on shorter-dated securities – are contributing to increased vulnerability of the market to a “sudden repricing,” according to the IMF. These dynamics can also become self-reinforcing, the fund said.
“If investors grow concerned about a country’s rollover capacity, they may demand higher yields or step back from auctions of sovereign bonds altogether, validating the initial concern,” the IMF said, effectively explaining what happens when a Ponzi scheme stops working.
“The resulting political pressure to address rising costs of servicing debt may itself become a source of uncertainty that markets price in.”
Meantime, the Iran war will stoke new fiscal pressures, forcing governments to choose between cushioning their economies from rising energy costs or keeping a lid on borrowing, the IMF also said.
“The Middle East has added a new source of fiscal pressure to an already strained global landscape,” it said. “In a scenario of prolonged conflict, global debt-at-risk could increase by an additional 4 percentage points,” the IMF said, using a term that refers to the danger of repayment difficulties in an adverse scenario.
As finance ministers and central bankers from around the world gather in the US capital this week for the spring meetings of the IMF and World Bank, the fund chided most major economies on their fiscal policies, starting with the US which has “no debt consolidation plan in sight” – the IMF certainly is correct there – while China’s persistent large deficits are continuing to add to its borrowing load, which is also accurate, but fails to discuss China’s relentless dumping of products which are collapsing its core export markets as their manufacturing sectors implode as they can’t complete with Chinese state subsidies. Several European Union member nations have triggered escape clauses from the union’s rules on deficits in order to fund defense spending, the IMF noted.
But the US has a special role, given how reverberations in the Treasuries market spread across the world, the IMF said.
“The transmission is global: supply-driven increases in US yields spill over almost one-for-one to foreign bond markets, disproportionately affecting countries reliant on external financing,” the IMF said.
