Columbia Business School's esteemed finance professor, Charles Calomiris, highlights a potential risk looming over the US Treasury bond market due to escalating federal deficits.
Drawing upon the interplay of monetary and fiscal policies, Calomiris suggests that unchecked federal deficits could deter investors from government-issued debt, compelling the central bank to intervene.
The root of this apprehension is the perceived inflation risk stemming from accumulated debt. Calomiris explains, "A potential outcome of consistent deficits could lead to the central bank's intervention in buying government debt, which is tantamount to money printing."
The cycle is straightforward yet concerning: as the US government continues to accumulate debt, it may find fewer takers for its bonds due to growing unease about the country's deficits. In such a scenario, the Federal Reserve might feel compelled to purchase these bonds, an action synonymous with money printing, which may induce inflation.
The real danger, as Calomiris indicates, isn't about the interest rates but rather a point where, regardless of the rates, investors might be unwilling to engage with further government debt. Such a situation could culminate in a failed bond auction.
The bond market's trajectory already appears unsettling, with 10-year Treasury yields recently surpassing the 5% mark, a peak not observed since 2007. The escalating federal deficit, combined with climbing interest rates, means the government is shouldering higher debt servicing costs.
External observers, too, have voiced concerns. In a notable move, Fitch Ratings downgraded the US government's credit rating last August, pointing to governance lapses concerning fiscal and debt decisions. Market veterans like Ed Yardeni invoke the return of the "bond vigilantes", who historically offloaded US Treasurys in the '90s, urging the government to moderate its spending habits.
Recent Treasury bond auctions have indeed shown signs of diminishing demand. A case in point: a fortnight ago, the US floated $20 billion of 30-year bonds, with dealers having to absorb 18% of the offering, a marked rise from the usual 11%.
Calomiris underscores the urgent need to address the deficit. He warns, "Without intervention to manage the projected deficits tied to our entitlement programs, we might soon face tumult in the bond market, potentially spiraling into significant inflation."
