Government Debt & Bond Yield Anxieties?

Worries about government deficits and debt have been a chronic concern which probably is responsible for keeping too many investors, too cautiously invested, too much of the time.

Anxiety about government debt and bond yields is growing, as concerns about unsustainable government deficits are thought to be eroding demand for federal debt. Several commentators on Wall Street suggest investors may be rethinking the safety of U.S. Treasury bonds and warn of a growing risky debt regime. Indeed, as the President’s current tax bill recently moved through the House, Moody’s lowered the U.S. government’s credit rating from its traditional AAA citing rising interest costs and burgeoning deficits. Many increasingly believe interest rates have been rising for all the wrong reasons. Not because of strong economic growth but rather due to rising inflation fears and worsening government deficits. Some recent disappointing Treasury auctions have only added to fears that something is running amok in the bond market.

Rising fear surrounding the bond market seems to be based on a couple factors. First, many are concerned that with public debt rising out of control relative to the size of nominal GDP, the U.S. government could simply go broke being unable to meet ballooning debt service. Second, investors are increasingly worried because the size of debt issuance is becoming overwhelming large relative to the demand for fixed-income securities. Sustainably selling an ever-rising supply of bonds will require considerably higher yields.

For a host of reasons, I think these worries are grossly overstated. Fears the U.S. is near bankruptcy or will be forced to default on Treasury debt are hyperbolized. Although these concerns have long been politically motivated and emotionally charged, the chance of them becoming a reality is probably near zero. The ballooning supply of U.S. bonds could represent a much more legit issue, but there is some indication bonds are actually in short supply in most portfolios rather than in great abundance.