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Bloomberg Reports - We Should Quit Worrying About Treasuries Supply

Market Sell-Off

EDITOR NOTE: If the US Treasury Department issues more debt, flooding the market with supply, will there be enough demand to scoop it up? That’s what this article discusses in detail. The Fed’s plans to buy US Treasuries isn’t enough to absorb supply, China’s not likely to buy, though Japan and a few other countries are willing to take on what most others are trying to shed. Nevertheless, some experts below say there will be a market for it--like the line out of “Field of Dreams,” if you build it, they will come. But a more fundamental question remains, should we really be issuing more debt given our current debt bubble?

(Bloomberg) -- Bill Murray’s rousing speech in “Meatballs” had his character reassure summer campers fearing failure with the refrain “it just doesn’t matter, it just doesn’t matter, it just doesn’t matter.”

That’s pretty much what some experts are saying about the record deluge of U.S. government debt this year, when it comes to its potential impact on bond yields. Morgan Stanley’s Guneet Dhingra put it this way in a note Wednesday: “supply will go up. So will demand.”

The Federal Reserve’s plan to buy about $80 billion of Treasuries a month isn’t sufficient to mop up the federal government’s issuance. The Treasury Department last month said it expected to issue about $677 billion in marketable debt in the July-to-September quarter. And recent T-bill sales have shown evidence of supply concerns, potentially affecting interbank rates.

Nevertheless, Dhingra, Morgan Stanley’s head of U.S. interest-rate strategy, predicted that “an increase in Treasury demand will match the upcoming additional supply.”

While China is unlikely to help, overall foreign demand will probably rise, with Japan in particular having scope to boost purchases, Dhingra wrote. “Domestic investment funds, including mutual funds, have been a strong source of demand for Treasuries and are likely to remain so,” he added. Money-market funds are also seen as buyers, and Dhingra highlighted evidence that hedge funds stepped up during 2008-09 and 2018-19 episodes.

‘Not Potatoes’

It’s a fundamental misconception to think of supply and demand for Treasuries in the same way as, say, for potatoes, according to HSBC Holdings Plc’s Steven Major. While conceptually it might sound reasonable that bigger supply would drive down prices, that doesn’t work without considering demand, he wrote in a deep-dive look at the issue earlier this year.

Major found that government-bond demand is elastic, meaning it’s responsive to price: cheaper prices mean buyers are willing to take down a larger amount, in turn diminishing the price move when supply shifts out.

“Whilst supply expectations can have an impact” on intraday trading of bonds, “they are not meaningful to the long-term horizon bond yield forecasts,” Major wrote. “Even a big increase in supply does not have to result in a meaningful shift lower in the price.”

Yields ultimately are determined by expectations for short-term interest rates, plus any premium for buying longer-dated securities, the theory states. So it would take boosting prospects for growth and inflation to lift yields, Major concluded.

Originally posted on Yahoo! Finance

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All articles are provided as a third party analysis and do not necessarily reflect the explicit views of GSI Exchange and should not be construed as financial advice.

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