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July 12, 2017 at 12:46 PM
(Bloomberg Prophets) — The playbook for U.S. Treasuries hasn’t changed much since the end of the Great Recession. First, traders come into a new year with a bearish bias, pushing up yields on the expectation that the conundrum of extremely low long-term rates will finally unwind as the economic recovery pushes on. Then, there’s a gradual capitulation as the global demand for Treasuries and disinflationary forces persist, driving yields lower in defiance of the Federal Reserve’s aggressiveness.
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Things are about to change in at least one key respect — the Fed will finally start unwinding its gargantuan $4.5 trillion pile of Treasury and mortgage securities in just a few months, convinced that the crisis-averting quantitative easing measure is no longer needed. The withdrawal of central bank support for the Treasury market will come at an inopportune time for the debt managers at the Treasury Department because of the outlook for rapidly growing budget deficits. That combination will put massive upward pressure on Treasury yields as the government ramps up bond sales. It won’t help that the European Central Bank is also starting to talk about pulling back.
Just two weeks ago the bipartisan Congressional Budget Office raised its 2017 deficit estimate to $693 billion, or $134 billion higher than their guess at the start of the year. The CBO’s estimates for 2018 through 2027 were bumped higher by a hefty $550 billion. With the Fed rolling over less of the proceeds from its maturing bond holdings into new securities, the Treasury will be forced to raise auction sizes quite dramatically over the next few years after a long period of stability. The prolonged era of acute Treasury shortages could come to a crashing halt — and soon.
