The first warning was in mid February, the bad news was that led by China, foreign countries dumped U.S. Treasury bills at a record rate in December. The worry was that the weak marketplace lead to a rise in interest rates to make the bills more attractive to investors. The interest rate rise which could be the beginning of an inflationary period. According to the Treasury Department foreign holdings of U.S. Treasury bills fell by a record $53 billion in December. That topped the previous record drop of $44.5 billion in April 2009.
In the intervening six weeks since the December report was released the market for US Treasury Bills has not stabilized. Investors are braced for a further sell-off in US Treasuries after the passing of Obamacare hes raised fears that a massive increase of US government debt will add to the already saturated market for US Treasuries.
The yield on 10-year Treasuries – the benchmark price of global capital – surged 30 basis points in just two days last week to over 3.9pc, the highest level since the Lehman crisis. Alan Greenspan, ex-head of the US Federal Reserve, said the abrupt move may be “the canary in the coal mine”, a warning to Washington that it can no longer borrow with impunity. He said there is a “huge overhang of federal debt, which we have never seen before”.
David Rosenberg at Gluskin Sheff said Treasury yields have ratcheted up 90 basis points since December in a “destabilising fashion”, for the wrong reasons. Growth has not been strong enough to revive fears of inflation. Commodity prices peaked in January and US home sales have fallen for the last three months, pointing to a double-dip in the housing market.
Spain’s downward spiral spooks bond investorsMr Rosenberg said the yield spike recalls the move in the spring of 2007 just as the credit system started to unravel. “The question is how the equity market is going to handle this back-up in rates,” he said.
The trigger for last week’s sell-off was poor demand at Treasury auctions, linked to the passage of the Obama health care reform. Critics say it will add $1 trillion (£670bn) to America’s debt over the next decade, a claim disputed fiercely by Democrats.
It is unclear whether China is selling US Treasuries after cutting its holdings for three months in a row, or what its motive may be. There are concerns that Beijing may be sending a coded message before the US Treasury rules next month on whether China is a “currency manipulator”, though experts say China is clearly still buying dollar assets because it is holding down the yuan against the greenback. Some investors may be selling Treasuries as a precaution against a trade spat.
Looming over everything is the worry that markets will not be able to absorb the glut of US debt as the Fed winds down its policy of bond purchases, starting with an exit from mortgage-backed securities. It currently holds a quarter of the $5 trillion of the MBS market.
The rise in US bond yields has set off mayhem in the 10-year US swaps markets. Spreads turned negative last week, touching the lowest level in 20 years. The effect was to drive credit costs for high-grade companies such as Berkshire Hathaway below that of the US government. This may have been a technical aberration.