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U.S. Debt and the Bond Market

November 7th, 2016 by

When the economic policies of the country are debated, it usually comes down to fiscal and budgetary concerns: How much do we spend? How much debt do we take on?

Over the past several years, the “recovery” of the U.S. economy has been fueled by rising debt, ultra-low interest rates, and profligate spending. The recent sell-off in Treasurys means that the bond market rout and debt problem could get a lot worse before they get better.

National Debt

So much of the focus in discussions of the economy is on things like growth (as measured by gross domestic product) and unemployment. The fact that it’s an election year is also the source of a lot of media interest and market curiosity. The potential “Black Swan” for the financial markets that nobody is talking about, however, is the mounting U.S. debt.

Source: ccPixs.com CC BY-SA 3.0

Source: ccPixs.com [CC BY-SA 3.0]

The real national debt is now approaching $20 trillion. While the trade deficit has been reduced under President Obama, his administration has added to the debt burden at an accelerating clip. (Keeping the economy afloat following the financial crisis is often cited as the cause.) Government debt and spending in Obama’s time have outpaced even the Bush years. Moreover, as historically low interest rates are set to rise, that debt will become more expensive to service. The interest payments alone on the debt amounted to $433 billion for the Treasury Department this past fiscal year.

This pile of debt left behind by the Obama administration will have ramifications on the future of the U.S. economy.

Bond Rout

Although mainstream economists often discount the importance of how large the national debt grows, it undoubtedly has an effect on important markets and the broader economy. (Plus, prudently managing your country’s debt makes sense on an intuitive level.)

For example, after bond-buying reached a frenzy level the last two years, central banks like the Federal Reserve have been seeing dwindling demand for government bonds. The current 10-year yield in the U.S. is up to 1.82%. Up until recently, accommodative Fed policy contributed greatly to the bull market in Treasurys. At the same time, though, the aggressive stimulus for financial institutions from those who make monetary policy has not necessarily led to more loan activity.

David Keeble, who is the chief of fixed-income strategy at Credit Agricole SA, says that the Fed “probably wants it both ways—they want more lending to keep the economy going, but more safe lending, which means less lending.”

killing-bull-marketBy and large, banks and corporations are simply sitting on their subsidized cash stockpiles. Commercial banks are currently hoarding $2.4 trillion in U.S. Treasurys. This “new money” is not being put into the economy. Instead, financial institutions are relying upon the safest liquid assets, making it more difficult to generate wider profit margins. Meanwhile, spending on research, development, and new investments by companies on Wall St has been effectively nonexistent. Foreign entities like China have actually been dumping Treasurys for three straight quarters—an unprecedented trend.

“Whatever the case,” Bloomberg explains, “it’s clear that while the excess liquidity from the Fed’s easy-money policies has been a boon for government securities, banks are still wary of putting much of the cash to work.”

While the issue of the national debt may not be an immediate crisis, its effects will surely continue to weigh on the global economy.

 

The opinions and forecasts herein are provided solely for informational purposes, and should not be used or construed as an offer, solicitation, or recommendation to buy or sell any product.