There’s a ‘significant risk to markets’ that’s a bigger worry than where the economy is headed next

REUTERS/Philip Massie

• The Treasury Department is set to increase its bond sales to support the government’s funding needs.
• According to Deutsche Bank’s Torsten Slok, this incoming supply flood is a “significant risk to markets” that’s worth more attention than the US economy’s nuts and bolts.
• Several central banks, among the biggest buyers of Treasurys and key sources of demand, are getting ready to slow their bond buying.

The Treasury Department’s forthcoming increase in debt sales poses “a significant risk to markets,” according to Torsten Slok, Deutsche Bank’s chief international economist.

Treasury plans to slowly increase its issuance of coupon-bearing securities to support the government’s funding needs. This will be crucial as the gap between spending and income continues to widen. The US deficit jumped to a record $665.7 billion in the most recent fiscal year, and could hit $1 trillion in a decade, according to analyses of the new tax law.

One way the government plans to fund all that spending is by borrowing from the public. And this means that the Treasury’s issuance of bonds is set to surge.

There just needs to be interested buyers.

“The bottom line is that investors should spend less time looking at US economic fundamentals and more time on where a doubling in demand for US fixed income can come from, in particular in a world where central banks at the same time stop doing QE,” Slok said in a note on Tuesday.

He continued: “If demand for US fixed income doesn’t double over the coming years then US long rates will move higher, credit spreads will widen, the dollar will fall, and stocks will likely go down as foreigners move out of depreciating US assets. And this could happen even in a situation where US economic fundamentals remain solid.”

Deutsche Bank

The Treasury Department is selling $62 billion in coupon-bearing bonds in the three months through February, when it’s expected to announce an increase.

This comes at a time when one of the biggest sources of demand for Treasurys — central banks — appears to be retreating to the backseat.

After the financial crisis, central banks in the US, Japan, and Eurozone helped keep interest rates low by buying up several billions worth of Treasurys. When demand for the bonds rises and increases their prices, their yields fall.

But the global economy is now in recovery.

The Fed is already shrinking its balance sheet, partly by not reinvesting $6 billion of its maturing Treasurys every month.

Last week, the European Central Bank and Bank of Japan spooked investors with news that suggested they were slowing their bond purchases.

Also, senior Chinese government officials reportedly urged slowing or stopping their buying of Treasurys. All this news sent the benchmark 10-year yield to its highest level in 10 months.