Saturday, March 27, 2010

Supply fears start to hit Treasuries

The threat of hyper-inflation still exists. Once the market for US Bonds gets too expensive or dries up completely, the only recourse our government will have to finance all the deficit spending will be to print more money, thus inflating our currency, a hidden tax, to what extent we do not know.

The bond vigilantes are finally flexing their muscles. A long period of stability for the US government bond market showed signs of cracking this week as a lack of investor appetite for new debt sent the benchmark 10-year yield to its highest level since last June.

The fact that German Bunds have outperformed both Treasuries and gilts in recent months highlights this increasing worry over public debt. Germany’s budget deficit is much lower than the US and UK and inflation there is also expected to remain low.

“The spotlight on Greece only helped to reveal that the US’s kitchen – with Federal and state budget balances – was itself full of cockroaches,” says William O’Donnell, strategist at RBS Securities.

It hasn’t helped that the US announced a big overhaul of its healthcare system this month, adding to worries about the scale of US spending.

“The environment for debt auctions has turned negative,” says Rick Klingman, managing director at BNP Paribas. “Long-term rates are rising and it is no coincidence that this has occurred after the passage of healthcare reform and the end of Fed buy-backs.”

Also rattling US investors this week was a report by the Congressional Budget Office that falling payroll taxes due to high unemployment, means that the social security programme will pay out more in benefits than it receives for this fiscal year. “A sustained rise in yields is upon us and bond funds will start to incur losses,” says Jim Caron, global head of interest rate strategy at Morgan Stanley. He expects 10-year yields to reach 4.50 per cent in the second quarter, as investors pull their money from bond funds. March looms as the first month for negative returns for investors in Treasuries this year.

Read The Financial Times article here.

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