US Bond ‘Death Spiral’ Risk Brushed Aside by Foreign Funds

By Investor Empires On Jan 16, 2025

(Bloomberg) — Whether you’re talking to Europe’s biggest CFO, Australia’s giant pension funds, or a cash-rich insurance company in Japan, there’s a resounding message you’ll hear when it comes to U.S. Treasuries: They’re still hard to come by. Defeated.

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Four months after new Vice President J.D. Vance said he was concerned that Treasuries face a potential “death spiral” if bond custodians seek to boost yields, firms including Legal & General Investment Management and Amundi SA say they are willing to give new management Advantage of the doubt.

There are plenty of reasons for global funds to buy even as Treasuries are mired in a historic bear market. The securities offer a huge yield premium compared to bonds in places like Japan and Taiwan, while Australia’s fast-growing pensions industry is adding Treasuries every month because of the market’s depth and liquidity. The United States also appears to be a safer bet than some European sovereign markets, which are grappling with financial problems of their own.

Investors were also relieved by Trump’s nomination of hedge fund manager Scott Besent to be Treasury Secretary, overseeing the government’s debt sales. Picent, whose Senate confirmation hearing is scheduled for Thursday, aims to reduce the deficit as a share of gross domestic product through tax cuts, spending controls, deregulation and cheap energy.

“In terms of the ‘death spiral’ risk, any bond market can become stuck in a cycle of boosting high yields and high debt expectations,” said Chris Jeffery, head of macro strategy and asset management at Legal & General Investment, UK. Largest asset manager. But “the new Treasury Secretary has talked about a 3% deficit goal in 2028. Bond investors have no reason to strike if the federal government embraces such aspirations.”

The attitude of foreign investors towards Treasuries is more important than ever. Foreign funds held $7.33 trillion worth of long-term US debt at the end of October, about a third of the amount owed, and slightly less than the record level of $7.43 trillion they held in September, based on the latest US government data.

At the heart of the debate over whether to continue buying Treasuries lies the largest US federal deficit outside extreme periods such as the pandemic and the global financial crisis. There are a number of signs that investors are becoming skittish. US benchmark 10-year bond yields have jumped more than a percentage point from their September low, and threaten to breach the key psychological level of 5% again.

10-year bond yields were little changed on Thursday after falling 14 basis points to 4.65% the previous day in response to benign US inflation data – the first decline in nine days.

Investors in Japan – the largest holders of Treasuries abroad – are aware of the increased risks but remain enthusiastic buyers.

“The prevailing view in markets is that the US Treasuries market is too large and liquid and US seigniorage is too entrenched to undermine the central role of Treasuries in global central bank reserves,” said Naomi Fink, chief global strategist at Nikko Asset Management in Tokyo. “. .

“In our central scenario, we expect the adjustment in US Treasury yields to continue in an orderly manner. However, the probability of a more disruptive adjustment, although still small, has increased in our view.”

One reason Japanese investors prefer Treasuries is that they provide exposure to the dominant dollar. Funds in the country would have earned a 12% return on their uncovered Treasury investments in 2024, with at least 11.5% of that due to the appreciation of the US currency.

View from Europe

European funds are also largely optimistic, saying any rise in Treasury yields is unlikely, especially as Trump appears aware of the need to keep global investors on side.

Markets are anticipating that the new administration will mean higher growth and inflation in the United States, causing the yield curve to steepen, but that actually makes Treasuries more attractive, said Anne Beaudeau, vice president of global aggregate strategies at Amundi.

“US bonds look more attractive at these levels, as higher yields will eventually weigh on growth prospects or the performance of risky assets, and the barrier to raising interest rates remains very high,” she said. “But the market will certainly remain cautious until we have more clarity on Trump’s agenda.”

At least some global funds are cautious about Treasuries as the US debt pile grows.

The budget deficit rose to $1.83 trillion for the fiscal year ending in September, according to the latest data published in October. The deficit is expected to swell further if Trump implements his pledges to cut taxes and boost spending.

“The curve will remain very steep with a lot of new issues coming to the market, and that is feeding into Treasuries negatively again,” said Caspar Hines, senior portfolio manager at RBC Bluebay Asset Management in London. He said there was at least a chance US yields would rise, similar to what happened in the UK during Prime Minister Liz Truss’ term in 2022.

The sell-off in Treasuries in recent weeks has convinced BlueBay to scale back some of its bets that 30-year bond yields will underperform two-year yields, the company said this week.

Marie-Anne Allier, a portfolio manager at Carmignac in Paris, said in an interview with Bloomberg TV that the company prefers short-term notes, as longer-term bonds are more vulnerable.

“There is no better place”

Investors in China, the second-largest holder of US debt abroad, view the possibility of a Treasury collapse as marginal.

“Even if concerns about rising borrowing costs and financial pressures in the United States are legitimate, the chance of seeing a catastrophic bond market collapse is very low,” said Ming Ming, chief economist in Beijing at CITIC Securities, one of the investors. One of the largest brokerage companies in China.

“If there is any unnecessary volatility in the US bond market, the Fed still has plenty of tools to stabilize and manage liquidity. That will help ease pressures,” he said.

Investors in Taiwan also continue to pour money into US debt.

“Momentum has not slowed despite expectations of slower or smaller rate hikes and talk of a ‘death spiral’,” said Julian Liu, head of Yuanta Securities Investment Fund. “In fact, we are seeing money continue to flow as yields rise.” , the largest local asset manager on the island.

“For most investors in Taiwan, the conclusion will likely be that there is no better place to invest.”

-With assistance from Xin Hua Wan, Liz Cabo McCormick, Jing Zhao, Masaki Kondo, Mia Glass, Alice Atkins, Betty Hu, and Iris Ouyang.

(Updates with Carmignac’s comment in paragraph 20.)