Tag Archives: Debt

US Household Debt Hits Record $13.5 Trillion As Delinquencies Hit 6 Year High

Total household debt hit a new record high, rising by $219 billion (1.6%) to $13.512 trillion in Q3 of 2018, according to the NY Fed’s latest household debt report, the biggest jump since 2016. It was also the 17th consecutive quarter with an increase in household debt, and the total is now $837 billion higher than the previous peak of $12.68 trillion, from the third quarter of 2008. Overall household debt is now 21.2% above the post-financial-crisis trough reached during the second quarter of 2013.

Mortgage balances—the largest component of household debt—rose by $141 billion during the third quarter, to $9.14 trillion. Credit card debt rose by $15 billion to $844 billion; auto loan debt increased by $27 billion in the quarter to $1.265 trillion and student loan debt hit a record high of $1.442 trillion, an increase of $37 billion in Q3.

https://www.zerohedge.com/sites/default/files/inline-images/total%20household%20debt%20q3%202018.jpg?itok=opBhuGsn

Balances on home equity lines of credit (HELOC) continued their downward trend, declining by $4 billion, to $432 billion. The median credit score of newly originating mortgage borrowers was roughly unchanged, at 760.

https://www.zerohedge.com/sites/default/files/inline-images/household%20debt%20q3%202018.jpg?itok=cL23-bYh

Mortgage originations edged up to $445 billion in the second quarter, from $437 billion in the second quarter. Meanwhile, mortgage delinquencies were unchanged improve, with 1.1% of mortgage balances 90 or more days delinquent in the third quarter, same as the second quarter.

Most newly originated mortgages continued went to borrowers with the highest credit scores, with 58% of new mortgages borrowed by consumers with a 760 credit score or higher.

https://www.zerohedge.com/sites/default/files/inline-images/originations%20q3%202018.jpg?itok=qy4GKtMH

The median credit score of newly originating borrowers was mostly unchanged; the median credit score among newly originating mortgage borrowers was 758, suggesting that with half of all mortgages going to individuals with high credit scores, mortgages remain tight by historical standards. For auto loan originators, the distribution was flat, and individuals with subprime scores received a substantial share of newly originated auto loans.

In what will come as a surprise to nobody, outstanding student loans rose $37BN to a new all time high of $1.44 trillion as of Sept 30. It should also come as no surprise – or maybe it will to the Fed – that student loan delinquencies remain stubbornly above 10%, a level they hit 6 years ago and have failed to move in either direction since…

https://www.zerohedge.com/sites/default/files/inline-images/delinquent%20balances%20q3%202018.jpg?itok=EOHP5Bnm

… while flows of student debt into serious delinquency – of 90 or more days – spiked in Q3, rising to 9.1% in the third quarter from 8.6% in the previous quarter, according to data from the Federal Reserve Bank of New York.

https://www.zerohedge.com/sites/default/files/inline-images/transitions%20into%20delinq.jpg?itok=rV_NSyqF

The third quarter marked an unexpected reversal after a period of improvement for student debt, which totaled $1.4 trillion. Such delinquency flows have been rising on auto debt since 2012 and on credit card debt since last year, which has raised a red flag for economists.

Auto loan balances also hit an all time high, as they continued their six-year upward trend, increasing by $9 billion in the quarter, to $1.24 trillion. Meanwhile, credit card balances rose by $14 billion, or 1.7%, after a seasonal decline in the first quarter, to $829 billion.

Despite rising interest rates, credit card delinquency rates eased slightly, with 7.9% of balances 90 or more days delinquent as of June 30, versus 8.0% at March 31. The share of consumers with an account in collections fell 23.4% between the third quarter of 2017 and the second quarter of 2018, from 12.3% to 9.4%, due to changes in reporting requirements of collections agencies.

Auto loan balances also hit an all time high, as they continued their six-year upward trend, increasing by $27 billion in the quarter, to $1.265 trillion. Meanwhile, credit card balances rose by $15 billion to $844 billion. In line with rising interest rates, credit card delinquency rates rose modestly, with 4.9% of balances 90 or more days delinquent as of Sept 30, versus 4.8% in Q2.

Overall, as of September 30, 4.7% of outstanding debt was in some stage of delinquency, an uptick from 4.5% in the second quarter and the largest in 7 years. Of the $638 billion of debt that is delinquent, $415 billion is seriously delinquent (at least 90 days late or “severely derogatory”). This increase was primarily due to the abovementioned increase in the flow into delinquency for student loan balances during the third quarter of 2018. The flow into 90+ day delinquency for credit card balances has been rising for the last year and remained elevated since then compared to its recent history, while the flow into 90+ day delinquency for auto loan balances has been slowly trending upward since 2012. About 215,000 consumers had a bankruptcy notation added to their credit reports in 2018Q3, slightly higher than in the same quarter of last year. New bankruptcy notations have been at historically low levels since 2016.

This quarter, for the first time, the Fed also broke down consumer debt by age group, and found that debt balances remain more concentrated among older borrowers. The shift over the past decade is due to at least three major forces. First, demographics have changed with large cohorts of baby boomers entering into retirement. Second, demand for credit has shifted, along with changing preferences and borrowing needs following the Great Recession. Finally, the supply of credit has changed: mortgage lending has been tight, while auto loans and credit cards have been more widely available.

https://www.zerohedge.com/sites/default/files/inline-images/borrowing%20age%20group.jpg?itok=5PLsESYJ

In addition to an overall increase in the share of debt held by older borrowers, there has been a noticeable shift in the composition of debt held by different age groups. Student and auto loan debt represent the majority of debt for borrowers under thirty, while housing-related debt makes up the vast majority of debt owned by borrowers over sixty.

https://www.zerohedge.com/sites/default/files/inline-images/loans%20by%20age%20group%20q3%202018.jpg?itok=ygoRLkGs

Confirming what many know, namely that Millennial borrowers are screwed, the Ny Fed writes that older borrowers have longer credit histories with more borrowing experience, as well as higher and typically steadier incomes; “thus, they often have higher credit scores and are safer bets for lenders.” Tighter mortgage underwriting during the years following the Great Recession has limited mortgage borrowing by younger and less creditworthy borrowers; meanwhile, student loan balances – and as most know “student” loans are usually used for anything but tuition – and participation rose dramatically and credit standards loosened for auto loans and credit cards. Consequently, there has been a relative shift toward non-housing balances among younger borrowers, while housing balances moved to the older and more creditworthy borrowers with lower delinquency rates and better performance overall.

And since this is a circular Catch 22, absent an overhaul of how credit is apportioned by age group, Millennials and other young borrowers will keep getting squeezed out of the credit market resulting in a decline in loan demand – and supply – which is slow at first and then very fast.

Source: ZeroHedge

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Interest On US Treasury Debt Hits $523 Billion As China Issues “Ron Swanson” Bonds

US debt continues to climbs along with interest rates. The interest paid to private banks and others on US Treasury debt has hit $523 BILLIION … and rising.

https://confoundedinterestnet.files.wordpress.com/2018/11/federalinterestvs10year.gif?w=736&zoom=2

Meanwhile, in China bondholders are being paid in ham instead of cash. Or perhaps bacon. Ron Swanson would approve!

Source: Confounded Interest

Goldman Warns Of A Default Wave As $1.3 Trillion In Debt Is Set To Mature

Ten years after the Lehman bankruptcy, the financial elite is obsessed with what will send the world spiraling into the next financial crisis. And with household debt relatively tame by historical standards (excluding student loans, which however will likely be forgiven at some point in the future), mortgage debt nowhere near the relative levels of 2007, the most likely catalyst to emerge is corporate debt. Indeed, in a NYT op-ed penned by Morgan Stanley’s, Ruchir Sharma, the bank’s chief global strategist made the claim that “when the American markets start feeling it, the results are likely be very different from 2008 —  corporate meltdowns rather than mortgage defaults, and bond and pension funds affected before big investment banks.

But what would be the trigger for said corporate meltdown?

According to a new report from Goldman Sachs, the most likely precipitating factor would be rising interest rates which after the next major round of debt rollovers over the next several years in an environment of rising rates would push corporate cash flows low enough that debt can no longer be serviced effectively.

* * *

While low rates in the past decade have been a boon to capital markets, pushing yield-starved investors into stocks, a dangerous side-effect of this decade of rate repression has been companies eagerly taking advantage of low rates to more than double their debt levels since 2007. And, like many homeowners, companies have also been able to take advantage of lower borrowing rates to drive their average interest costs lower each year this cycle…. until now.

According to Goldman, based on the company’s forecasts, 2018 is likely to be the first year that the average interest expense is expected to tick higher, even if modestly.

There is one major consequence of this transition: interest expenses will flip from a tailwind for EPS growth to a headwind on a go-forward basis and in some cases will create a risk to guidance. As shown in the chart below, in aggregate, total interest has increased over the course of this cycle, though it has largely lagged the overall increase in debt levels.

https://www.zerohedge.com/sites/default/files/inline-images/gsdebt1.jpg?itok=Yjz992Sy

The silver lining of the debt bubble created by central banks since the global financial crisis, is that along with refinancing at lower rates, companies have been able to generally extend maturities in recent years at attractive rates given investors search for yield as well as a gradual flattening of the yield curve.

According to Goldman’s calculations, the average maturity of new issuance in recent years has averaged between 15-17 years, up from 11-13 years earlier this cycle and <10 years for most of the late 1990’s and early 2000’s.

And while this has pushed back the day when rates catch up to the overall increase in debt, as is typically the case, there is nonetheless a substantial amount of debt coming due over the next few years: according to the bank’s estimates there is over $1.3 trillion of debt for our non-financials coverage maturing through 2020, roughly 20% of the total debt outstanding.

https://www.zerohedge.com/sites/default/files/inline-images/gsdebt2.jpg?itok=0CGcITP5

What is different now – as rates are finally rising – is that as this debt comes due, it is unlikely that companies will be able to roll to lower rates than they are currently paying. A second source of upward pressure on average interest expense is the recent surge in leverage loan issuance, i.e., those companies with floating rate debt (just 9% in aggregate for large caps, but a much larger percent for small-caps). The Fed Funds Futures curve currently implies four more rate hikes (~100 bp) through year-end 2019 (our economists are looking for 2 more than that, for a total of six through year-end 2019). While it is possible that some companies have hedges in place, there is still a substantial amount of outstanding bank loans directly tied to LIBOR which will result in a far faster “flow through” of interest expense catching up to the income statement.

While rising rates has already become a theme in several sectors such as Utilities and Real Estate, Goldman warns that this has the potential to be more widespread:

We saw evidence of this during the 2Q earnings season, where a number of companies cited higher interest expense as a headwind to reported earnings and/or guidance. Some examples:

  • “… we’re anticipating an increase in interest. It’s going to be n probably up in the $3.5mm, $4mm range, depending on interest rate increases… Obviously, we are anticipating floating rate increases if you think through the rate curve, so we embed that thinking into our forecast.” – Brinker International, FY4Q2018
  • “We expect net interest expense will be approximately $144 million [vs. $128 mn for the year ending February 3, 2018], reflecting an expectation for two additional rate increases as implied by the current LIBOR curve.” – Michaels Cos., 2Q2018
  • “Due largely to the effects of rising interest rates on our variable rate conduit facility, vehicle interest expense increased $9 million in the quarter… We continue to expect around $20 million higher vehicle interest expense due to rising U.S. benchmark interest rates.” – Avis Budget Group, 2Q2018

What does that mean for the bigger picture?

While many cash-rich companies have a remedy to rising rates, namely paying down debt as it matures, this is unlikely to be a recourse for the majority of corporations. The good news is that today, corporate America looks extremely healthy against a solid US economic backdrop. Revenue growth is running above trend, and EPS and cash flow growth are even stronger, boosted by Tax Reform.

And while Goldman economists assign a low likelihood that this will change anytime soon, there has been a sharp pickup in the “Recession 2020” narrative as of late. Specifically, along with the growth of the fiscal deficit which will see US debt increase by over $1 trillion next year, the fact that debt growth has outpaced EBITDA growth this cycle has implications for investors if and when the cycle turns.

Which brings us round circle to the potential catalyst of the next crisis: record debt levels.

According to Goldman’s calculations, Net Debt/EBITDA for its coverage universe as a whole remains near the highest levels this cycle, if not all time high. And while the bank cannot pinpoint exactly when the cycle will turn, it is easy to claim that US companies are “over-earning” relative to their cycle average today, a key points as the Fed continues “normalizing” its balance sheet. Indeed, this leverage picture looks even more stretched when viewed through a “normalized EBITDA” lens (which Goldman defines as the median LTM 2007 Q1-2018 Q2).

https://www.zerohedge.com/sites/default/files/inline-images/gsdebt3.jpg?itok=DDHa8fGv

There are two main factors that have driven this increase: net debt has increased while cash levels have declined:

  • the % of highly levered companies (i.e. >2x Net Debt/EBITDA) have nearly doubled vs. 2007 levels (even after EBITDA has improved for a large part of the Energy sector.)
  • The number of companies in a net cash position has declined precipitously to just 15% today down from 25% from 2006-2014.

Meanwhile, and touching on another prominent topic in recent months in which many on Wall Street have highlighted the deterioration in the investment grade space, i.e., the universe of “near fallen angels”, or companies that could be downgraded from BBB to junk, Goldman writes that credit metrics for low-grade IG and HY have been moving lower. If the cycle turns, the cost of debt could increase, with convexity suggesting that this turn could happen fast.

Picking up on several pieces we have written on the topic (most recently “Fallen Angel” Alert: Is Ford’s Downgrade The “Spark” That Crashes The Bond Market“), Goldman specifically highlights the potential high yield supply risk that could unfold.

Here are the numbers: currently there are $2tn of non-financial bonds rated BBB, the lowest rating across the investment grade scale. The amount has increased to 58% of the non-financial IG market over the last several years and is currently at its highest level in the last 10 years.

And for those wondering what could prompt the junk bond market to finally break – and Ford’s recently downgrade is precisely such a harbinger – Goldman’s credit strategists warn that this is important “because a turn in the cycle could result in these bonds being downgraded to high yield.”

From a market standpoint, too many bonds falling to the high yield market would create excess supply and potentially pressure prices. Looking back to prior cycles, approximately 5% to 15% of the BBB rated bonds were downgraded to high yield. If we assume the same percentages are applied to a theoretical down-cycle today, a staggering $100-300bn of debt could be at risk of falling to the high yield market in a cycle correction, an outcome that would choke the bond market and shock market participants. It is also the reason why Bank of America recently warned that the ECB can not afford a recession, as the resulting avalanche of “fallen angels” would crush the high yield bond market, sending shockwaves across the entire fixed income space.

And while such a reversal is not a near-term risk given solid sales/earnings growth and low recession risk, “it is potentially problematic given the current size of the high yield market is only $1.2tn.”

Should the market indeed turn, prices would need to adjust – i.e. drop sharply – in order to  generate the level of demand that would require a potential 25% increase in the size of the high yield market – especially at a time when risk appetite could be low.

https://www.zerohedge.com/sites/default/files/inline-images/gsdebt4.jpg?itok=cQT-grsj

Careful not to scare its clients too much, Goldman concedes that an imminent risk of a wave of credit rating downgrades is low, but warns that “the market could potentially be overlooking the underlying cost of capital/financial risks (high leverage, low coverage) for certain issuers based on their current access to market.

* * *

As for the worst case scenario, it should be self-explanatory: a sharp slowdown in the economy, coupled with a major repricing of bond market risk could result in a crash in the bond market, which together with the stock market has been the biggest beneficiary of the Fed’s unorthodox monetary policies. Furthermore, should companies suddenly find themselves unable to refinance debt, or – worse – rollover debt maturities, would lead to a wave of corporate defaults that starts at the lowest level of the capital structure and moves its way up, impacting such supposedly “safe” instrument as leveraged loans which in recent months have seen an explosion in issuance due to investor demand for higher yields.

To be sure, this transition will not happen overnight, but it will happen eventually and it will start with the riskiest companies.

To that end, Goldman has created a watch list for those companies that are most at risk: the ones with a credit rating of BBB or lower that are paying low average interest rates (less than 5%), have limited interest coverage (EBIT/Interest of <5x) and high leverage (Net Debt/EBITDA>2.5x) based on 2019 estimates; the screen is also limited to companies where Net Debt is a substantial portion of Enterprise value (30% or higher). The screen is hardly exhaustive and Goldman admits that “there are much more highly levered companies out there that could be more  exposed to a turn in the cycle.” However, the bank focuses on this subset given the low current interest cost relative to the risk-free rate, “suggesting investors could be complacent around their financing costs.”

In other words, investors who are exposed to debt in the following names may want to reasses if holding such risk is prudent in a time when, for the first time in a decade, the average interest expense is expected to tick higher.

https://www.zerohedge.com/sites/default/files/inline-images/gsdebt5.jpg?itok=KpIU11pk

….. and than there’s political pressure.

Source: ZeroHedge

Consumer Credit Expansion Continues During Q1, 2018

https://www.newyorkfed.org/medialibrary/media/images/v4/press_center/home-prices-homeownership-and-housing-wealth.jpg?h=320&w=640&la=en

Total Household Debt Rises for 15th Straight Quarter, Led by Mortgages, Student Loans

Just Released: New York Fed Press Briefing Highlights Changes in Home Equity and How It’s Used

Household Debt And Credit Report Q1, 2018

Remarks at the Economic Press Briefing on Homeownership and Housing Wealth

A Close Look at the Decline of Home Ownership

 

Why the US Economy is Stuck in an Irreversible Destructive Cycle

In a further signal of the weakening US economy, borrowing amongst US consumers continue to grow which correspondingly sees the total outstanding debt rise to new highs. In addition, and we have discussed this in some detail in our subscription podcasts, there has been a rise also in the delinquency rates across multiple sectors, including auto loans, credit cards and mortgages.

US Household debt now stands at around $13tn, rising around 4.5% in the last 12 months, fueled in part, by credit card debt and also the auto loan sector. Such unsustainable debt is further compounded by stagnant wage growth, zero contract hour jobs, poorly paid service sector employment and the increasing move towards part-time employment opportunities.

This is all the more reason why talk of the Fed raising interest rates is farcical because not only will stagnant wage growth and rising household debt, seriously impact consumer spending, but rising interest rates will further impact economic growth and cause further rises in delinquency rates. This is precisely why interest rates are raised to dampen what might be termed an overheating economy, something we most certainly could not attribute to the current US economy.

There is no doubt that stagnant wage growth is impacting consumer spending but it is also likely to lead to a greater demand for credit which in turn exacerbates the debt and delinquency cycle further. There is no doubt that US household debt will continue to rise and if the Fed was to ever seriously consider raising interest rates it is going to seriously impact those trying to service debt in a stagnant wage growth environment. Delinquency rates continue to rise with e.g. credit card debt delinquencies rising 7.5% year-on-year, and mortgage debt rising 4% year-on-year.

This is a clear example of why QE and ZIRP has been deeply damaging to the US economy. Relatively low-cost borrowing has encouraged this level of indebtedness, coupled with questionable practices concerning the refinancing of existing and delinquent loans.

Given that a service based economy and consumer spending is responsible for nearly three-quarters of the total US GDP, coupled with rising delinquency rates, it is quite clear that this debt cycle is unsustainable and the current $13tn bubble is going to burst, at some point, with disastrous consequences for the US economy.

To put this in further context, total US consumer debt is now 15% higher than it was during the economic crisis of 2008. When we factor in rising costs coupled with stagnant wage growth it will become increasingly difficult for US consumers to met their minimum monthly payment obligations, never mind begin to lower their debt levels.

The sad irony is that the primary economic driver in the US economy, namely consumer spending, coupled with the insane long-term QE/ZIRP policy means that in order for the US economic to avoid implosion, consumers must continue to feed the frenzy at whatever personal cost to themselves, which will ultimately contribute to the economic implosion.

Source: The Sirius Report

The Way Out of Debt-Serfdom: Fanatic Frugality

Debt is serfdom, capital in all its forms is freedom.

If we accept that our financial system is nothing but a wealth-transfer mechanism from the productive elements of our economy to parasitic, neofeudal rentier-cartels and self-serving state fiefdoms, that raises a question: what do we do about it?

The typical answer seems to be: deny it, ignore it, get distracted by carefully choreographed culture wars or shrug fatalistically and put one’s shoulder to the debt-serf grindstone.

There is another response, one that very few pursue: fanatic frugality in service of financial-political independence. Debt-serfs and dependents of the state have no effective political power, as noted yesterday in It Isn’t What You Earn and Owe, It’s What You Own That Generates Income.

There are only three ways to accumulate productive capital/assets: marry someone with money, inherit money or accumulate capital/savings and invest it in productive assets. (We’ll leave out lobbying the Federal government for a fat contract or tax break, selling derivatives designed to default and the rest of the criminal financial skims and scams used so effectively by the New Nobility financial elites.)
The only way to accumulate capital to invest is to spend considerably less than you earn. For a variety of reasons, humans seem predisposed to spend more as their income rises. Thus the person making $30,000 a year imagines that if only they could earn $100,000 a year, they could save half of their net income. Yet when that happy day arrives, they generally find their expenses have risen in tandem with their income, and the anticipated ease of saving large chunks of money never materializes.
What qualifies as extreme frugality? Saving a third of one’s net income is a good start, though putting aside half of one’s net income is even better.
The lower one’s income, the more creative one has to be to save a significant percentage of one’s net income. On the plus side, the income tax burden for lower-income workers is low, so relatively little of gross income is lost to taxes.
The second half of the job is investing the accumulated capital in productive assets and/or enterprises. The root of capitalism is capital, and that includes not just financial capital (cash) but social capital (the value of one’s networks and associations) and human capital (one’s skills and experience and ability to master new knowledge and skills).
I cover these intangible forms of capital in my book Get a Job, Build a Real Career and Defy a Bewildering Economy.
Cash invested in tools and new skills and collaborative networks can leverage a relatively modest sum of cash capital into a significant income stream, something that cannot be said of financial investments in a zero-interest rate world.
Notice anything about this chart of the U.S. savings rate? How about a multi-decade decline? Yes, expenses have risen, taxes have gone up, housing is in another bubble–all these are absolutely true. That makes savings and capital even more difficult to acquire and more valuable due to its scarcity. That means we have to approach capital accumulation with even more ingenuity and creativity than was needed in the past.
https://i1.wp.com/www.oftwominds.com/photos2017/savings-rate.gif
Meanwhile, we’ve substituted debt for income. This is the core dynamic of debt-serfdom.
https://i0.wp.com/www.oftwominds.com/photos2017/consumer-credit5-17.jpg

As Aristotle observed, “We are what we do every day.” That is the core of fanatic frugality and the capital-accumulation mindset.

For your amusement: a few photos of everyday fanatic frugality (and dumpster-diving).

https://i1.wp.com/www.oftwominds.com/photos10/frugal-wok.jpg

https://i2.wp.com/www.oftwominds.com/photos10/frugal-food.jpg

https://i1.wp.com/www.oftwominds.com/photos10/frugal-sandal.jpg

https://i2.wp.com/www.oftwominds.com/photos10/frugal-slippers.jpg

https://i2.wp.com/www.oftwominds.com/photos10/frugal-bikeseat.jpg

The only leverage available to all is extreme frugality in service of accumulating savings that can be productively invested in building human, social and financial capital.

Debt is serfdom, capital in all its forms is freedom. Waste nothing, build some form of capital every day, seek opportunity rather than distraction.

Debt = Serfdom (April 2, 2013)

How Frugal Are You? (August 7, 2010)

By Charles Huge Smith | Of Two Minds

 

Beware: The $10 Trillion Glut of Treasuries Can Suddenly Pull Interest Rates Up, as Big Deficits Loom

  • Net issuance seen rising after steady declines since 2009

  • Fed seen adding to supply as Treasury ramps up debt sales

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Negative yields. Political risk. The Fed. Now add the U.S. deficit to the list of worries to keep beleaguered bond investors up at night.

Since peaking at $1.4 trillion in 2009, the budget deficit has plunged amid government spending cuts and a rebound in tax receipts. But now, America’s borrowing needs are rising once again as a lackluster economy slows revenue growth to a six-year low, data compiled by FTN Financial show. That in turn will pressure the U.S. to sell more Treasuries to bridge the funding gap.

No one predicts an immediate jump in issuance, or a surge in bond yields. But just about everyone agrees that without drastic changes to America’s finances, the government will have to ramp up its borrowing in a big way in the years to come. After a $96 billion increase in the deficit this fiscal year, the U.S. will go deeper and deeper into the red to pay for Social Security and Medicare, projections from the Congressional Budget Office show. The public debt burden could swell by almost $10 trillion in the coming decade as a result.

All the extra supply may ultimately push up Treasury yields and expose holders to losses. And it may come when the Federal Reserve starts to unwind its own holdings — the biggest source of demand since the financial crisis.

“It’s looking like we are at the end of the line,” when it comes to declining issuance of debt that matures in more than a year, said Michael Cloherty, head of U.S. interest-rate strategy at RBC Capital Markets, one of 23 dealers that bid at Treasury debt auctions. “We have deficits that are going to run higher, and at some point, a Fed that will start allowing its Treasury securities to mature.”

After the U.S. borrowed heavily in the wake of the financial crisis to bail out the banks and revive the economy, net issuance of Treasuries has steadily declined as budget shortfalls narrowed. In the year that ended September, the government sold $560 billion of Treasuries on a net basis, the least since 2007, data compiled by Bloomberg show.

 

Coupled with increased buying from the Fed, foreign central banks and investors seeking low-risk assets, yields on Treasuries have tumbled even as the overall size of the market ballooned to $13.4 trillion. For the 10-year note, yields hit a record 1.318 percent this month. They were 1.57 percent today. Before the crisis erupted, investors demanded more than 4 percent.

Net Issuance of U.S. Treasuries, Fiscal-Year Basis
Net Issuance of U.S. Treasuries, Fiscal-Year Basis

One reason the U.S. may ultimately have to boost borrowing is paltry revenue growth, said Jim Vogel, FTN’s head of interest-rate strategy.

With the economy forecast to grow only about 2 percent a year for the foreseeable future as Americans save more and spend less, there just won’t enough tax revenue to cover the burgeoning costs of programs for the elderly and poor. Those funding issues will ultimately supersede worries about Fed policy, regardless of who ends up in the White House come January.

As a percentage of the gross domestic product, revenue will remain flat in the coming decade as spending rises, CBO forecasts show. That will increase the deficit from 2.9 percent this fiscal year to almost 5 percent by 2026.

“As the Fed recedes a little bit into the background, all of these other questions need to start coming back into the foreground,” Vogel said.

The potential for a glut in Treasuries is emerging as some measures show buyers aren’t giving themselves any margin of safety. A valuation tool called the term premium stands at minus 0.56 percentage point for 10-year notes. As the name implies, the term premium should normally be positive and has been for almost all of the past 50 years. But in 2016, it’s turned into a discount.

Some of the highest-profile players are already sounding the alarm. Jeffrey Gundlach, who oversees more than $100 billion at DoubleLine Capital, warned of a “mass psychosis” among investors piling into debt securities with ultra-low yields. Bill Gross of Janus Capital Group Inc. compared the sky-high prices in the global bond market to a “supernova that will explode one day.”

Despite the increase in supply, things like the gloomy outlook for global growth, an aging U.S. society and more than $9 trillion of negative-yielding bonds will conspire to keep Treasuries in demand, says Jeffrey Rosenberg, BlackRock Inc.’s chief investment strategist for fixed income.

What’s more, the Treasury is likely to fund much of the deficit in the immediate future by boosting sales of T-bills, which mature in a year or less, rather than longer-term debt like notes or bonds.

“We don’t have any other choice — if we’re going to increase the budget deficits, they have to be funded” with more debt, Rosenberg said. But, “in today’s environment, you’re seeing the potential for higher supply in an environment that is profoundly lacking supply of risk-free assets.”

Deutsche Bank AG also says the long-term fiscal outlook hinges more on who controls Congress. And if the Republicans, who hold both the House and Senate, retain control in November, it’s more likely future deficits will come in lower than forecast, based on the firm’s historical analysis.

FED HOLDINGS OF TREASURIES COMING DUE

2016 ────────────── $216 BILLION

2017 ────────────── $197 BILLION

2018 ────────────── $410 BILLION

2019 ────────────── $338 BILLION

However things turn out this election year, what the Fed does with its $2.46 trillion of Treasuries may ultimately prove to be most important of all for investors. Since the Fed ended quantitative easing in 2014, the central bank has maintained its holdings by reinvesting the money from maturing debt into Treasuries. The Fed will plow back about $216 billion this year and reinvest $197 billion in the next, based on current policy.

While the Fed has said it will look to reduce its holdings eventually by scaling back re-investments when bonds come due, it hasn’t announced any timetable for doing so.

“It’s the elephant in the room,” said Dov Zigler, a financial markets economist at Bank of Nova Scotia. “What will the Fed’s role be and how large will its participation be in the Treasury market next year and the year after?”

by Liz McCormick & Susanne Barton | Bloomberg