Buried in the IMF’s latest Financial Stability Report is a graph that I cannot get out of my head. It shows the huge surge in sovereign debt in the advanced economies since 2010 by location of issuer and the holder of the debt.
Source: Figure 1.13 from IMF Global Financial Stability Report October 2017
As things stand in 2017 two thirds of the new sovereign debt issued by the advanced economies since 2010 – essentially the US, Eurozone, UK and Japan – have been absorbed by official bond-buying i.e. successive iterations of QE. Of the one third that have been absorbed by private investors the overwhelming majority is US sovereign debt. That preponderance of US debt issuance in the global supply of advanced economy sovereign debt, is set to increase spectacularly over the next five years. Once we allow for fiscal consolidation in Europe and vast bond buying in Japan, the only large net borrower will be the US.
One might be tempted to see this as a potential source of vulnerability. How can US Treasuries retain their standing in relation to German Bunds given this vast imbalance in supply? On the other hand, one can say with equal reason that the US will be the only net supplier of “safe assets” i.e. highly rated sovereign debt, to the global financial system. Asset managers need to invest assets and the pile of assets they have to invest grows continuously. On the basis of the IMF’s data, US public debt is the only obvious safe haven for trillions of dollars in savings that need to be stowed away for years to come.
Predicting how exactly those two impulses – the US fiscal imbalance and the global demand for safe assets – will balance out is a highly uncertain business. In the first few months of the Trump Presidency the prospect of big deficits sent US Treasury prices down and yields up. Those expectations collapsed in the spring. The bond market lost faith in the ability of the Trump administration to deliver. Pessimism about long-run growth and inflation prospects returned. With that kind of outlook Treasuries offering a predictable income flow are a more attractive investment, so prices rose and yields fell. 12 months on from the 2016 election, with the Fed leadership question open the markets are bopping up and down, driven by guesses about Republican tax policy. On days when tax cuts seem likely to make it through and conservative candidates look likely to replace Yellen, the markets sell off bonds and then reverse their position on new news.
As one investor commented to the FT on October 25th: ““This is not about economic optimism … Sell-offs that don’t have an economic thesis behind them don’t typically sustain.”” So here’s my question. What should our “economic thesis” about the medium-term outlook for global sovereign bond markets be? I’m not putting this as an investment question but as a question in political economy? What is the balance in this market going to look like? I would be fascinated to get views. I am thinking of making this the final section of an essay I have to finish by the weekend on the politics of sovereign debt since the crisis. So, hot takes are most welcome.
The only thing that seems certain is that viewed in the large the entire question of sovereign debt and its management seems likely to become concentrated on “the US” i.e. the complex assemblage of Congress, Treasury, the Fed, the bond and forex markets. Everything else will be a side show. Presumably the only caveat to that rather monolithic outlook is China, China, China.
Folks, please jump in!