US Debt Surge Could Spike Global Borrowing Costs
The International Monetary Fund issued a warning on Wednesday regarding the increasing scale of US debt issuance, stating that it is undermining the premium that Treasuries have historically commanded from investors. This development carries significant implications for government securities worldwide. “The increase in the US Treasury security supply is compressing the safety premium that US Treasuries have traditionally commanded — an erosion that pushes up borrowing costs globally,” the Washington-based fund stated in its latest Fiscal Monitor report. The US has been selling substantial amounts of debt due to a budget deficit that has averaged approximately 6 percent of gross domestic product over the last three years — a historically significant shortfall, typically seen only during wartime or recession periods. The Congressional Budget Office indicates that the gap is anticipated to remain at those levels over the next decade. The IMF highlighted a narrowing gap between the yields of AAA rated corporate bonds and Treasuries, indicating a diminished attractiveness for US government securities. While spreads have typically been viewed as a gauge of the risk investors estimate for corporate borrowers, the fund is essentially flipping that analysis to view it as a metric of how much extra buyers are willing to pay for Treasuries. “A narrowing spread implies that the premium investors pay for the safety and liquidity of Treasuries (relative to high-grade corporate debt) is compressing,” the IMF stated. The fund presented a chart illustrating that AAA corporate spreads have contracted to approximately 35 basis points, down from over 55 basis points at the beginning of 2019.
The IMF has identified another risk: the growing dependence of the US Treasury on the issuance of short-dated debt. Treasury Secretary Scott Bessent last year stated that it didn’t make sense to expand issuance of longer-dated securities, given that their yield levels were above those of bills, which mature in up to a year. “When debt is concentrated at shorter maturities, governments must refinance more frequently, increasing their exposure to abrupt shifts in market conditions or investor sentiment,” the fund said, noting that the US along with a number of other governments has shifted reliance toward sales of bills. The US Treasury’s shift toward bills “has noticeably shortened the average maturity of the US debt portfolio, increasing the frequency of rollover and overall gross financing needs,” the IMF stated. Wednesday’s warnings arrive three weeks prior to Bessent’s Treasury unveiling its latest strategy for US debt issuance, referred to as the quarterly refunding policy statement. The IMF has highlighted the growing influence of hedge funds in the Treasuries market, particularly through cash-futures basis trades, identifying this as a potential risk. “The liquidity that hedge funds supply through such trades can be prone to flight, as it is backed by more-leveraged investors: a spike in volatility or financing costs can trigger forced unwinding, amplifying price dislocations,” it stated. According to the IMF, multiple elements — historically high borrowing needs, the composition of demand for Treasuries tilting toward hedge funds, and the increasing reliance on shorter-dated securities — are contributing to the market’s heightened vulnerability to a “sudden repricing.”
Empirical estimates for the United States indicate that debt ratios exhibit heightened sensitivity to monetary policy shocks when a government’s debt composition includes a significant proportion of short-term instruments. The fund stated that these dynamics can also become self-reinforcing. “If investors grow concerned about a country’s rollover capacity, they may demand higher yields or step back from auctions of sovereign bonds altogether, validating the initial concern,” the IMF stated. “The resulting political pressure to address rising costs of servicing debt may itself become a source of uncertainty that markets price in.” Meanwhile, the conflict in Iran will create additional fiscal pressures, compelling governments to decide between shielding their economies from escalating energy costs or restraining their borrowing, the IMF also stated. “The Middle East has added a new source of fiscal pressure to an already strained global landscape,” it stated. “In a scenario of prolonged conflict, global debt-at-risk could increase by an additional 4 percentage points,” the IMF stated, employing a term that denotes the peril of repayment challenges in a negative context.
As finance ministers and central bankers from around the globe convene in the US capital this week for the spring meetings of the IMF and World Bank, the fund admonished most major economies regarding their fiscal policies. The US has “no debt consolidation plan in sight,” while China’s persistent large deficits are continuing to add to its borrowing load. Several European Union member nations have activated escape clauses from the union’s regulations on deficits to finance defense expenditures, as noted by the IMF. However, the United States holds a unique position, as the IMF noted, due to the way fluctuations in the Treasuries market resonate globally. “The transmission is global: supply-driven increases in US yields spill over almost one-for-one to foreign bond markets, disproportionately affecting countries reliant on external financing,” stated the IMF.
