Looking for trouble in Treasuries

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There’s a far-fetched but intriguing (and unnerving) line in this morning’s note from Deutsche Bank’s strategist Jim Reid, after the obligatory mention of golf:

His emphasis below:

The bond vigilantes have certainly camped out on the lawn of the US fixed income market this week as the sell-off entered its third consecutive day on Thursday (10yr UST +9.6bps) in the shadow of US Treasury credit quality jitters and confirmation of increased Treasury supply in the coming quarter. I’ve not heard anyone mention the comparison but there is a minor similarity to what happened with the UK last September and October. Back then an ambitious pro-growth UK budget by the new Prime Minister and Chancellor prompted sudden fears of heavy extra gilt supply, yields then surged and the LDI crises magnified it and we ended up with; UK asset managers having huge liquidity issues, BoE intervention, mass political top level resignations and a complete U-turn of a budget. Of course there are important differences, not least the Dollar has rallied slightly this week whereas Sterling slumped last year when the mini-crisis happened.

For the US the confusing thing is how much of the budget deficit increase of late is due to delayed tax receipts (due to winter storms) and how much is due to genuine stealth fiscal easing. It still feels like the former to me but that’s not to say that the weak US fiscal situation isn’t unparalleled in non-recessionary or non-crises times. Also there’s no denying that tax receipts are lower and interest costs higher at the moment so the increased issuance in the next few months is real. As such treasuries are making room for the extra supply. We’ll wait and see if it triggers any issues anywhere.

The US Treasury market has certainly been soft lately, as our mainFT colleagues wrote yesterday. We’re a bit more sceptical it has much to do with the US Treasury’s latest refunding announcement, and suspect it has much more to do with the rising “no-landing” narrative. After all, it was not a surprise that US government debt auctions were getting larger.

Here’s what fabled macro tourist Bill Ackman had to say overnight:

I have been surprised how low US long-term rates have remained in light of structural changes that are likely to lead to higher levels of long-term inflation including de-globalization, higher defense costs, the energy transition, growing entitlements, and the greater bargaining…

— Bill Ackman (@BillAckman) August 3, 2023

But Reid seeing faint potential parallels to last year’s LDI-stirred Gilt market mayhem is interesting.

Of course, LDI is a MUCH smaller component of the vastly bigger, much more liquid US Treasury market, so it’s a struggle to see how it could snowball in a similar way. As Reid points out, the dollar is strengthening rather than weakening, so there are no signs of spooked foreign investors bailing, as they did in the UK. But perhaps one to watch.

Anyway, Reid’s talk about the Biden Administration’s “stealth fiscal easing” — triggered by the growing budget deficit despite the still-healthy economy — has been comprehensively demolished by former Alphavillain Matt Klein.

As he wrote in The Overshoot:

The downturn in revenues is mostly attributable to the plunge in capital gains tax receipts after the windfall of 2021/2022, as well as the collapse in dividends paid by the Federal Reserve to the Treasury. Meanwhile, the increase in outlays is almost entirely attributable to the surge in interest payments on Treasury debt. Lower taxes and higher spending are boosting private sector disposable income, but this attribution suggests that the beneficiaries will not use much if any of the extra cash to pay for goods, services, or real assets. The “stimulative” impact is therefore likely to be much smaller than what might be expected based on the headline numbers.