In focus

Shifting US Treasury market signals move into uncharted waters


It has been an extraordinary year in the financial markets. Even the US Treasury market, the largest and most liquid market in the world, experienced unprecedented turbulence in March. While most asset prices have recovered swiftly, the costs of mitigating the economic impact of the pandemic are still stacking up. With the US government deficit at a peace time high, the spending must be financed by new government bond issuance.

As fixed income investors look ahead, there are two key questions on their minds: who will purchase the heavy supply of US Treasuries issuance associated with the historically large US budget deficit. And if the supply and demand imbalances could result in higher bond yields and renewed volatility.

Before analysing the supply and demand in the Treasury market, we should first look at the savings and investments balance of the US. Structural forces driving savings and investment can help to explain, among other things, what happened in March when the Federal Reserve (Fed) had to purchase $1.5 trillion of bonds to stabilize the Treasury market.

US savings and investments balance

At a high level, an open economy can be split into the public, private and external sectors. When the savings and investments balance of a sector is negative, this means that the sector’s savings are not sufficient to finance investments and it has to borrow to fill the gap. Figure 1 shows the historical sectoral balances of the US economy.

Starting with the public sector, apart from a few years around the turn of the century, the US public sector has been a net borrower for a long time because of persistent budget deficit. Between 1997 and 2001 and again between 2004 and 2008, the US private sector was also a net borrower. The second period coincided with rapid growth in mortgage debt, culminating with the financial crisis.

To finance the budget deficit, the US government can either borrow from the private sector, or when the domestic savings are not sufficient, from abroad. Since domestic investments have usually exceeded domestic savings, the US has been running a persistent current account deficit, which peaked at 6% of GDP in 2007.

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