Turbulent Times for Bonds as Administration Faces Market Pressure

Turbulent Times for Bonds as Administration Faces Market Pressure

Of course, that’s easier said than done, especially this week when the bond market has experienced historic volatility. On Thursday, the 10-year yield fell a little, but it is still about 37 bps above where it started the week. That’s a huge increase in yield, which is being manifested in the pricing of all sorts of debt — mortgages, credit card balances, auto loans, you name it. As a consequence, Americans—both typical consumers and businesses—are paying much higher costs to borrow.

The United States is in the midst of an unprecedented import boom. That’s $1.7 billion less circulating within the economy. This is worrisome given the administration’s stated focus to reduce one of the U.S.’s biggest problems, a trade deficit hovering just under $800 billion. Analysts warn that such efforts could worsen foreign selling pressures in the medium term, adding to an already-complex landscape for the economy.

The bond market has recently provided the administration an unexpected reprieve. This newly created space allows them to avoid imposing further tariffs that could have escalated the economic tensions. Observers note that the bond market effectively urged President Donald Trump to reconsider his tariff strategies, potentially averting a more severe financial crisis.

Treasury Secretary Scott Bessent described the bond market’s recent turmoil as “an uncomfortable but normal deleveraging,” despite concerns over investor confidence. The bond market is in volatile due to the continual unwinding of arcane trades including interest rate products. On top of that, a potentially explosive fiscal environment in Washington has even the most enthusiastic investors understandably nervous.

Hedge funds need to generate cash either to fund their burgeoning operational expenses or, more critically, to meet margin calls or cover illiquid positions. This ever-growing need is further straining the bond market. In a yield-starved world, investors have come calling. They seek to mitigate the greater risks associated with U.S. Treasury securities, long regarded as low-risk investments.

The administration still seems committed to the idea of reducing yields to lower borrowing costs. All of its efforts are severely undermined by a deeply unstable fiscal climate. By the end of this year, the annual budget deficit is expected to exceed $2 trillion. The surge in the 10-year yield following a Federal Reserve cut signals growing apprehension about current policies and their implications for economic stability.

Dr. Ed Yardeni, the very sophisticated Wall Street analyst and forecaster, noted this dramatic change in focus from equities to fixed income.

“If he wasn’t paying attention to the stock market, now we know he’s paying attention to the bond market.” – Ed Yardeni

Yardeni further explained the mood of the bond market. He noted that there is increasing frustration with both the current administration’s zero-interest rate monetary policy and their trade policies.

“The bond vigilantes don’t like what monetary policy is doing and they certainly don’t like what Trump is doing on the trade side.” – Ed Yardeni

Fears of financial stress are catching up with anxiety and depression. Joseph Brusuelas, chief economist with the influential firm RSM, recently noted that major dislocations in the bond market would inevitably increase fiscal pressure.

“When something like that happens, you’re going to get a significant increase in financial stress. Until that abates, we have to assume that there are going to be further issues.” – Joseph Brusuelas

The culprit behind this recent bond market blowup can be traced back to a combination of underlying, yet related, factors. As an example, Brusuelas explained that the unwinding of basis swaps trades has driven yields sharply higher. This is not the only influence in effect.

“Right now, the unwinding of the basis swaps trade is the primary reason, but not the sole source, of the increase in yields across the Treasury curve.” – Joseph Brusuelas

Additionally, he noted that hedge funds are under enormous stress to sell assets to try and meet cash needs.

“Funds ‘are having to raise prodigious quantities of cash that results in the selling of Treasurys.’” – Joseph Brusuelas

May 05, 2021 Market observers are intensely following these developments. Investors are reorienting themselves to a new and more volatile paradigm defined by higher yields and fiscal restraint. The most severe effects will be felt by consumers and private businesses. As we discussed above, increasingly expensive borrowing due to higher yields would likely amplify any negative growth shocks, too.

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