With the Fed now openly warning that there may actually come a time when the 'flow' stops; the most recent Treasury Borrowing Advisory Committee (TBAC) report has some concerning statistics for those change-ridden hopers who see a smooth Fed exit, deficit-reduction, and blue skies ahead. While they are careful not shout 'sell' in a crowded bond market; hidden deep in the 126 page presentation are two charts that bear significant attention. The first shows what TBAC expects (given the market's expectations) to happen to interest rates in the US as the Fed 'exits' its QE program (taper, unwind, hold) - the result, the weighted-average cost of financing for the US government will almost triple from around 1.6% to around 4.3% over the next ten years. But more problematic is that even with CBO's rather conservative estimates of the growth in US debt over the next decade the USD cost of financing will explode from around $205bn (based on TBAC data) to over $855bn. Still convinced the Fed can exit smoothly?
As TBAC warns:
Treasury yields could reprice notably when the market is convinced that policy tightening is imminent
There is a risk that markets may overshoot to higher-than-fair yield levels due to:
- Concerns about Fed portfolio unwind
- Inadequate interest hedging in certain asset classes
- Portfolio rebalancing by retail investors
Annual interest cost on public debt to increase more than 400% (from $205 bn in 2013 to $855 bn in 2023)
- Main driver : Increase in WAC from 1.7% to 4.3%
- Secondary factor : ~ 65% increase in stock of debt
Given the market's expectations for Fed tapering (or gradual tightening)...
[5]
The marginal cost of financing will rise significantly...
[6]
but with the sheer size of debt now (and growing), that will balloon the absolute cost of servicing US debt to over $850bn per year...
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And just what happens to all those retirees - who need yield - who are being herded into stocks when Treasuries pay over 4.5%? Would seem bullish for bond flows... think Japan...
Charts: TBAC