Bond Yields Sink To New Lows And Federal Deficits Skyrocket As Bitcoin Slumps
Yields Plumb New Lows, but ‘Century Bonds’ Remain Scarce. Bond Yields Sink To New Lows And Federal Deficits Skyrocket As Bitcoin Slumps
In the U.S., yields aren’t negative, yet. But 30-year government bond yields this month fell below 2% for the first time, prompting the Treasury Department to express interest in selling debt with 50- and 100-year maturities. Yields for 30-year government bonds have fallen below zero in Holland, Denmark and Switzerland, and below 1% in the U.K., Portugal and Spain.
Only a handful of governments have taken advantage of the chance to sell ultralong bonds at the current low rates.
Bond yields in many countries world-wide have fallen to record lows this summer. Yet few governments have responded as many bankers and investors say they should, by locking in ultralow rates for decades.
Germany on Wednesday sold 30-year government bonds at a negative interest rate for the first time, meaning investors are effectively paying the government to hold their money. Europe’s largest economy raised €824 million ($914 million) by selling bonds that will be worth €795 million at maturity in 2050.
Just a handful of governments have taken advantage of the opportunity to sell ultralong bonds, those maturing in at least 50 years, at such low rates. Ireland and Belgium sold 100-year bonds in 2016, and Austria and Argentina followed the year after.
Switzerland, Japan and Sweden have sold bonds maturing in 10 years or more at negative yields.
That has led many investors and analysts to ask why more governments aren’t taking action. Many proponents of large-scale bond issuance at ultralow rates say policy makers are missing an easy opportunity to raise funds that could help generate jobs and income by, for instance, financing the rebuilding of crumbling roads and bridges, for starters.
“There’s free money on the table for the U.S.,” said Adam Posen, president of the Peterson Institute for International Economics. “There’s no reason for the U.S. to hesitate.”
The politics of debt issuance have grown fraught in recent years, with government deficits rising in the wake of the 2008 financial crisis and again recently. But markets haven’t been concerned about deficits recently, with U.S. yields falling despite a rising budget gap. Those worried about the accumulation of government debt should realize that locking in low interest rates for very long terms is ultimately very prudent, said Mr. Posen.
A few countries have tried. Ireland and Belgium each sold €100 million of 100-year bonds in privately placed deals in 2016. Argentina sold $2.75 billion of that maturity in 2017, while Austria sold €3.5 billion of 100-year bonds that year and followed-on with €1.25 billion more in June.
Before the era of negative interest rates, China sold 100-year bonds in 1996, followed by the Philippines in 1997 and Mexico in 2010.
Some countries, including the U.K., France, Belgium, Italy and Spain have sold 50-year bonds totaling roughly $130 billion since the start of 2014, according to Refinitiv.
Ultralong bonds have a natural audience, in institutions such as insurers that have long-term liabilities and need to match them with long-dated assets. Many analysts contend there is generally a dearth of safe, long-term assets right now, and that this shortage is part of the dynamic that has driven bond yields down so sharply in 2019.
That said, investors have some reservations about buying ultralong bonds. They can be volatile and few are outstanding, so liquidity, the capacity to buy or sell at listed prices, can be fleeting. The 100-year bonds sold by Austria have traded at times 70% above face value. Should global interest rates begin to climb, those gains could evaporate.
The value of Argentina’s 100-year bonds have fallen by nearly half after Argentina’s pro-business President Mauricio Macri lost a primary election this month, indicating that he may be defeated in October’s election.
Of the roughly $15 trillion of bonds with negative yields globally, about $3 trillion were sold at their offering with negative yields, while the rest fell below zero as the securities appreciated during the global bond market rally. A bond’s yield becomes negative when its value in the market exceeds its principal to be returned at maturity and the sum of all its future interest payments.
Some investors who buy negative-yielding debt own it as a hedge for other parts of their portfolios. Holding bonds with negative yields can also be a more palatable option for institutional investors who face surcharges for keeping deposits in a bank. Others may buy negative-yielding bonds because they believe their prices will appreciate as economic growth slows and inflation falls, conditions many investors expect to prevail in coming months.
One other possible reason for buying them: skepticism that the novel responses of global central bankers to the global growth shortfall will prove effective.
“You’re running negative rates and it hasn’t had the desired consequence,” said Jack McIntyre, who manages global bond portfolios for Brandywine Global Investment Management. “You’re going to need something more.”
Federal Deficits To Grow More Than Expected Over Next Decade, CBO Says
CBO boosts 10-year forecasts for budget deficits by $809 billion, citing two-year budget deal.
Federal deficits are projected to grow much more than expected over the next decade thanks to the two-year budget agreement lawmakers and the White House struck last month, the Congressional Budget Office said Wednesday.
The agency increased its forecasts for deficits over the next decade by $809 billion, to $12.2 trillion, in updated budget projections released Wednesday. The increase primarily reflects higher federal spending under the new budget deal, partly offset by lower projected interest rates.
CBO said the new agreement, which increased spending roughly $320 billion over the next two years above previously enacted spending caps, will add roughly $1.7 trillion to deficits between 2020 and 2029. That reflects CBO’s assumption that federal spending will continue to grow at the rate of inflation after 2021.
Higher spending on disasters and border security in 2019 also boosted projected deficits by $255 billion over the next 10 years, assuming that spending continues to grow. CBO also downgraded its forecasts for U.S. interest rates, which will reduce expected interest costs on government debt by $1.4 trillion over the next decade.
Deficits as a share of gross domestic product are expected to average 4.7% over the next decade, up from the 4.3% average CBO projected in May, and a significant increase from the 2.9% average over the past 50 years.
Overall, CBO said government debt as a share of the economy is expected to rise from 79% this year to 95% in 2029—up from 92% when the agency released its 10-year forecasts in May.
“The nation’s fiscal outlook is challenging,” CBO Director Phillip Swagel said. “To put it on a sustainable course, lawmakers will have to make significant changes to tax and spending policies—making revenues larger than they would be under current law, reducing spending below projected accounts, or adopting some combination of those approaches.”
Lawmakers have shown little appetite, however, for reining in federal spending or raising taxes, and investors are unfazed by the government red ink.
The latest projections come as White House officials are considering potential stimulus measures that would help cushion the U.S. economy from a potential downturn but would likely add billions more to government debt.
Risks of a deepening economic downturn appear to be rising abroad and could be spreading to the U.S. economy, as heightened trade tensions and slower global growth weigh on economic activity.
CBO said Wednesday higher tariffs are expected to reduce the level of U.S. GDP by 0.3% by 2020, primarily by raising prices, which reduces consumers’ purchasing power and increases the cost of business investment. Tariffs also reduce average real household income by $580, or 0.4%, by 2020, CBO projected.
Higher federal spending is expected to bolster the economy from some of those effects over the next few years: CBO lifted its forecast for GDP to 2.1% in 2020, from a projected 1.7% in January, and 1.8% in 2021, up from 1.6% in January.
While government borrowing costs remain historically low, high and rising debt could constrain policy makers in the next downturn. Research has shown countries with higher debt-to-GDP ratios during a crisis have weaker recoveries, in part because policy makers worry about borrowing more to stimulate the economy.
Deficits typically shrink when the economy is doing well, as low unemployment and rising wages push up tax revenues for the government, and automatic spending on safety-net programs such as unemployment insurance declines.
Instead, deficits as a share of the economy have been rising in recent years despite an uptick in economic output, and annual deficits are on track to eclipse $1 trillion in fiscal 2019, which ends Sept. 30. Although government receipts have begun to pick up 18 months after the 2017 tax cuts took effect, they haven’t kept pace with rising federal spending or broader economic growth.
The Treasury Department said last month it expects to borrow more than $1 trillion for the second year in a row.
In Reversal, Trump Says He Is No Longer Considering Tax Cuts
President had said Tuesday he wanted to bolster the economy by reducing capital gains, payroll taxes.
President Trump said Wednesday he wasn’t currently looking at any form of tax cuts, a reversal from a day earlier when he floated possible moves to bolster economic growth.
“I’m not looking at a tax cut now,” Mr. Trump said in comments to reporters on the South Lawn of the White House. “We don’t need it. We have a strong economy.”
Mr. Trump has maintained the economy remains on a strong footing despite some recent warning signs, but he has also pressured the Federal Reserve to cut interest rates, which he argues would supercharge growth.
n his comments Wednesday, he ruled out a cut in the payroll tax and also said he wasn’t looking to reduce capital-gains taxes by indexing gains to inflation. He said indexing could be seen as “somewhat elitist” and would benefit wealthier households rather than American workers.
But he said indexing remained an option and that he believed he had authority to make changes, a point that is in dispute.
A day earlier, Mr. Trump told reporters in the Oval Office that he was considering measures to bolster the economy, including lowering capital-gains taxes and a possible reduction in payroll taxes.
Payroll taxes, which are separate from the federal income tax, fund Medicare and Social Security, and a reduction would boost workers’ take-home pay.
“We’re looking at various tax reductions,” he had said Tuesday. “We’re talking about indexing. And we’re always looking at the capital gains tax, payroll tax….I would love to do something on capital gains. We’re talking about that.”
The president has sent conflicting messages on whether he believes he could lower capital-gains taxes unilaterally. On Tuesday, he said he could “directly” index gains to inflation—a belief that conflicts with a 1992 opinion in which the Justice Department’s Office of Legal Counsel concluded that Treasury lacked the authority to define the word “cost” to include inflationary gains. The attorney general at the time, William Barr, is again the attorney general.
On Wednesday, Mr. Trump suggested he no longer believed he could do so unilaterally.
The economic expansion this summer became the longest on record in the U.S. Unemployment is exceptionally low and consumer spending appears robust, but warning signs are flashing. Growth in economic output slowed to a 2.1% annual rate in the second quarter from a 3.5% annual rate in the second quarter of 2018.
‘It’s a Crisis’; Lumber Mills Slash Jobs as Trade War Cuts Deep
U.S. exports of hardwood lumber to China have fallen 40% this year.
The big bet that U.S. hardwood lumber companies placed on China over the past two decades is collapsing.
China was a savior of sorts for the industry after the financial crisis last decade. Customers there kept buying oak and ash boards in large quantities, while construction and furniture production fell in the U.S.
Now, after Beijing placed retaliatory tariffs of up to 25% on imports of lumber and other U.S. wood products, exports of hardwood lumber to China have fallen 40% this year.
U.S. hardwood lumber exports to China have plunged as the trade fight has intensified.
The lower demand pushed U.S. hardwood lumber prices down 20% in August from a year earlier and prompted companies to seek government assistance. A slowing Chinese economy also has reduced demand.
“It’s a crisis the likes of which we just never had to deal with before,” said Matthew Gutchess, president of Gutchess Lumber Co. in Cortland, N.Y. “The demand elsewhere is just not absorbing what China is dropping.”
Gutchess’s revenue has fallen 25% this year. In response, the company reduced overtime and suspended contributions to employee 401(k) retirement plans.
Baillie Lumber Co. of Hamburg, N.Y., another large producer, has eliminated several dozen jobs. Lumber processor Northland Corp. of La Grange, Ky., has cut its workforce of 75 people in half.
China was buying a growing share of U.S. hardwood lumber exports until the trade war.
“Were we relying too much on East Asia and China? Of course we were,” said Orn Gudmundsson Jr., chief executive of Northland. “But there were no viable alternatives.”
Northwest Hardwoods Inc. of Tacoma, Wash., one of the largest domestic producers of hardwood lumber, is closing plants in Buena Vista, Va., and Mt. Vernon, Wash., that together employ 100 people.
Northwest Chief Executive Nathan Jeppson said the Trump administration’s attempt to win trade concessions for the U.S. overall has had an opposite, detrimental effect on a hardwood lumber industry that is reliant on exports to China.
“We feel stuck in a much larger chess match,” Mr. Jeppson said. “My fingers are cramping from how long they’ve been crossed.”
The White House has said the president is standing up to unfair trade practices that harm U.S. manufacturers.
China is the top export market for U.S. hardwood, especially for higher-grade materials used to make furniture like oak cabinets and cherry dining tables. Lower grades remain in demand in the U.S. to make shipping pallets and railroad ties. Softwoods, like pine, are used mainly for construction.
U.S. lumber mills started ramping up exports to China two decades ago. At first it was fashioned there into furniture and exported to countries including the U.S.
Now most of it stays in China to feed a growing fondness for oak furniture and cabinets among the country’s growing middle and upper classes, according to Michael Snow of the American Hardwood Export Council, a trade group.
The U.S. sent 54% of all of its exported hardwood lumber by volume to China in the first seven months of 2018, up from less than 5% in 2000, according to the council. In the first seven months of this year, the share of exports dropped to 41%.
Other countries have been increasing their share of the Chinese market. Russia and Gabon now account for 17% of imports by value through July, up from 12% through July of last year.
Mr. Snow said the closure of U.S. lumber mills could lead to more American logs being shipped overseas to be cut into lumber there. He said it is unclear if those mill jobs would return when the trade dispute eases.
Some lumber companies want to encourage U.S. consumers to buy more hardwood products such as furniture and flooring as the trade dispute continues.
Jim Hourdequin, chief executive of Lyme Timber Co., a private-equity firm focused on land for growing hardwood timber, wants the industry to fund a marketing campaign similar to the “Got Milk?” advertisements the dairy industry produced in the 1990s. A push for such a program failed in 2015 after opposition from some parts of the hardwood industry.
The U.S. Agriculture Department has given more than $5 million to the hardwood lumber industry through its Agricultural Trade Promotion Program, a department spokesperson said.
Some lumber company executives have met with members of Congress and the Trump administration to request aid similar to the assistance that farmers have received since China cut back purchases of U.S. crops and livestock. The Commerce Department said it doesn’t have a mechanism to distribute trade relief to the industry.
“There is no question that these tariffs have virtually destroyed a segment of our industry,” said Steven M. Anthony, president of Anthony Timberlands. “If they are passing money around, I guess we’ve got to get our share.”
How To Solve The Mystery of Falling Bond Yields
When the Fed signals it will taper bond buying, yields drop. If this sounds counterintuitive, don’t worry.
Perhaps the big drop in Treasury yields over the past three months is really a modern version of the taper tantrum.
That probably sounds odd, since back in 2013 the taper tantrum—a bond-market panic about the Federal Reserve cutting its Treasury purchases—prompted the exact opposite reaction, and 10-year yields soared from 1.6% in May of that year to above 3% by the end of December.
But bear with me: What happened when the taper actually began was that yields dropped back, eventually falling all the way down to 1.6% again.
So here is a possibility: Investors have learned their lesson. The Fed is again readying the markets for the tapering of its bond purchases, but instead of a repeat of 2013’s tantrum, there has been a rush to buy bonds, and a big drop in yields.
If this sounds counterintuitive, don’t worry: Bond markets are weird. At its most basic, the 10-year yield is a measure of where investors think the Fed will set rates over the next 10 years, plus or minus an amount to reflect the risk of being wrong. The Fed buying bonds helps to reduce that risk premium, and so should, at least in the Fed’s theory, reduce yields, all else being equal. Tapering, therefore, should increase them.
But all else isn’t equal, for two reasons: First, tapering sends a signal about future moves in interest rates, as the Fed’s plan is to taper, then raise rates. It took until late 2015 last time for the first rate rise to come.
This time, futures markets think the first rise is more likely than not to come by December of next year. Any effect of the taper on the risk premium might be more than offset by the signal it sends about the future path of rates.
Second, that future path of rates is even more counterintuitive, because of the feedback loop with the economy. Raise rates sooner, and the economy and inflation should slow, meaning the Fed needs to raise rates less in future. Leave rates artificially low for too long, and in the future they will need to be raised more to get inflation back under control.
So the prospect of higher interest rates sooner can mean lower bond yields now. (Of course, if higher interest rates come in parallel with a stronger economy, that can offset the effect on yields, but the economic outlook has been weakening slightly.)
Not only is the expectation of a taper this year heightening the chance of a rate rise, but the Fed did in fact raise rates last month, albeit by a very small amount, to keep control of the bottom of its interest-rate band.
It isn’t the only thing going on, of course. With the benefit of hindsight, it looks like investors were too optimistic about economic reopening, as another Covid-19 wave hits places that haven’t inoculated enough people quickly enough. Hospitals are busy again with unvaccinated Covid-19 patients, and some countries in Europe and Asia are reintroducing restrictions. Slower growth and more risk to the economic outlook make bonds more attractive than equities.
There also is the countertrend rally issue. The rise in bond yields in the first three months of the year was very large, leading to the biggest loss on 30-year Treasurys in a quarter since at least 1980. After such a steep rise in yields, it is easy to put some of the subsequent decline down to positioning and rebalancing of portfolios.
Finally, it could be that economic models have changed. For the past decade or more, the basic model of lower rates leading to higher inflation hasn’t really worked, as globalization, online competition and weak worker power have ensured prices stay under control.
Sure, there is rapid inflation at the moment due to supply restrictions and staff shortages, but it is easy to see why investors might think that once those issues are resolved, the economy will return to how it was before the pandemic, with a weaker link between inflation and growth. The story of the 2010s was that central banks had to retreat every time they tried to tighten because heavy debt loads made economies far more sensitive to interest rates.
I think there is more risk of inflation in the long run than there was, as politics, globalization and the labor market shift, and bond yields so low are deeply unappealing. But if the drop in yields is correctly anticipating a Fed more willing to raise rates, that takes away the biggest reason to worry that the current bout of inflation will be allowed to feed on itself.
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