What happens if investors stop buying Treasury Bonds?
It is the sort of question that would have been scoffed at up until recent times, with Government Treasury Bonds – particularly those issued by the United States – seen as the ultimate bulwark and store of value in the investing universe.
However, with the US deficit growing quickly, bond yields rising but bond auctions attracting very weak demand, could it be that investors have simply lost interest in bonds after a torrid run of losses?
Also, could it be that rising bond yields are more of a sign of the need to attract investors at any cost rather than a sign that central banks will continue to raise official rates to fight inflation?
Certainly, there is some evidence that demand for bonds is waning, with a US T-bond auction last week encountering very weak demand with traders attributing that to fears that the sheer size of US government debt and subsequent bond issuance will overwhelm Wall Street.
US bond sales faltering
The US sold US$20 billion of 30-year bonds, but dealers had to take up 18% of the supply, well above the usual share of about 11%.
What is known as the auction tail, or gap between the lowest bid price versus the average, was the narrowest since November 2021, which is also a sign of waning demand.
Understandably, the yield on the 30-year Treasury jumped 12 basis points to 4.856%, and the 10-year yield surged 10 basis points to 4.7% – on the way to the dreaded 5% mark.
This auction followed on from other soft auctions including a US$46 billion sale of three-year notes and a US$35 billion sale of 10-year bonds.
US Government debt continues to pile up
There is no sign of the “supply” of fresh debt waning in the face of this weak demand, with the US Federal deficit still exploding and more than US$1 trillion of T-bills being sold since June.
One of the best customers for T-bills – the US Federal Reserve – is in the midst of a quantitative tightening campaign and is not reinvesting the proceeds of its maturing bond assets as it reduces the size of its balance sheet.
The only point of hope here is that the US Fed is still picking up some of the longer dated T-bills to moderate the effect of its quantitative tightening.
It is hard to criticise the buyers of T-bills for being cautious, after all Bloomberg figures show that losses on US Treasury bonds with maturities of 10 years or more had reached 46% since March 2020, while the 30-year bond had plunged 53%.
It should be remembered, however, that bonds produced a very long and profitable bull market for investors before that period when interest rates fell gradually over many years.
Bonds may no longer be a great store of value
While historically bonds might be seen as a safe place to store your money and a counter-weight to share exposures, those recent losses are right up there with some of the worst stock market crashes in history such as the dot-com bubble bursting.
The capital bond losses – which are incurred when interest rates rise suddenly, crushing the value of existing bonds with super low yields – are more extreme than previous bond-market meltdowns, even those that happened amid double digit interest rates.
Historically, many investors used a so-called 60/40 portfolio to smooth out returns and diversify their assets, with the 60% invested in shares seen as acting in the opposite direction to the more stable 40% bond portfolio.
The 60/40 portfolio is seen as somewhat dated now and it was absolutely smashed in 2022 when inflation spiked and the US Federal Reserve raised interest rates aggressively in response.
That crushed the price of both bonds and shares simultaneously, although since then we have started to see the lack of correlation come through as rising bond yields lead to falling share prices.
Australian demand for bonds really strong
Here in Australia it is a very different story, with a close to balanced Federal Budget and relatively light Government funding requirements producing strong investor demand for bonds, with fixed income ETF’s attracting the most cashflow of any asset class in the first half of this year.
Data from the ASX and Vanguard found Australian bond ETFs received $1.74 billion in the first half of 2023, up 54% since for this same period in 2022.
Similarly, international bond ETF’s received $763 million in the first half of 2023, which marked a meteoric 215% rise since the first half of 2022.
Collectively, net flows into Australian and global fixed income ETF products totalled some $2.5 billion over the first half of the year, Vanguard said.
With yields potentially near the peak, that has encouraged Australian investors to lock in higher rates on bonds, which tend to outperform cash and produce capital gains after the finish of a rate hike cycle.
Incredibly, inflows to bond ETFs have now surpassed those into Australian and global shares for the first time in the Australian ETF market history.