Governments, central banks, and bond investors

The author is an analyst for NH Investment & Securities. He can be reached at sw.kang@nhqv.com -- Ed.

Spiking real interest rates undermine fiscal sustainability. The US government will try to pace its spending and ease supply pressures through the TGA account. However, investors have no incentive to accelerate their bond investment before such efforts become visible. The door remains open for further bond yield increase.

Governments, central banks, and bond investors

Given the approaching 2024 presidential election and US-China-related disputes, the US government will want to spend even in the presence of favorable indicators, with bond issuance to be preferred over tax hikes. Wanting to stabilize inflation amid government stimulus, the Fed is hinting at stronger tightening. Meanwhile, bond investors are demanding higher interest rates (higher term premiums) while delaying selling or buying amid combined effects related to bond supply and tight monetary policy. The rational choices of individuals are conspiring to push 10yr nominal rates to new highs this cycle. And, real rates are the highest since Mar 2009.

Central banks aiming to control inflation welcome higher real yields. Investors also have less incentive to bid up bonds with real rates (1.95%) above potential growth (1.8%)—ie, there is no immediate reason for central banks or investors to change their minds due to a spike in bond yields.

Nevertheless, governments face the problem of fiscal sustainability, and the US is the entity most uncomfortable with a jump in real yields. As mentioned, however, political schedules and the external environment make meaningful spending cuts difficult. While we expect some eventual control in the pace of spending, we note that the government has raised its Treasury General Account (TGA) cash holdings target to US$750bn by yearend. But, with debt limit negotiations postponed to Jan 2025, there is little need to maintain such TGA balance level. We expect the government to utilize some of the TGA funds to finance spending and reduce supply-demand pressures in the market. Although this will weigh upon 2024 growth, it is the best the government can achieve for now.

As bond market vigilantes, we see no reason to rush in before confirming: 1) whether government efforts to ease supply pressure will materialize; and 2) the impacts of surging real bond rates on the economy and inflation. In the near term, the door remains open to 10yr US yield in the 4.4~4.5% range.

Jackson Hole and August BOK

The theme of this year’s Jackson Hole Symposium is structural changes in the global economy. Markets will be looking for hints from Mr. Powell on possible hikes to r* and i*. However, as market yields have already priced in a possible r* increase, there is little chance of a game changer.

At the last BOK meeting, the governor noted that the September FOMC would need to be considered in the BOK’s decisions. At the August BOK, we expect a unanimous vote for a policy rate freeze and principled comments such as ‘further hikes are possible’.