By Qudsia Bano

The US bond market  faces renewed pressure as investors brace for a possible Federal Reserve interest-rate hike while federal debt exceeding $40 trillion and heavy Treasury financing requirements keep longer-term borrowing costs elevated.

The pressure has intensified ahead of the Federal Open Market Committee’s September 15-16 meeting, as expectations for monetary tightening harden following hotter inflation readings and resurgent energy-price pressures. Major Wall Street banks, including Goldman Sachs, JPMorgan and Morgan Stanley, now expect the Fed to raise rates by 25 basis points at the meeting.

The Fed has kept its target range for the federal funds rate at 3.50-3.75% since the beginning of the year. At its July meeting, however, three policymakers dissented in favour of a 25-basis-point increase, signalling growing concern within the central bank over persistent inflation.

Those concerns have been reinforced by the latest inflation data. The Consumer Price Index increased 0.4% in August after rising 0.1% in July, while headline inflation stood at 3.4% year-on-year. Core prices, excluding food and energy, rose 0.3% during the month and 2.4% from a year earlier.

Bond markets have responded sharply. The benchmark 10-year Treasury yield moved above 5% on Tuesday, reaching its highest level since 2007 as rising oil prices, inflation concerns and expectations for tighter monetary policy intensified pressure on government bonds.

The pressure extends beyond expectations about the Fed’s short-term policy rate. Longer-dated Treasury yields also reflect investor concerns over inflation, fiscal deficits and the growing supply of government debt.

The rise in yields is occurring against an increasingly challenging fiscal backdrop. US total public debt crossed $40 trillion for the first time in August, adding to concerns over the volume of government securities investors that will have to absorb. The combination of large fiscal deficits, heavy government and corporate issuance and the $40 trillion debt milestone has contributed to pressure at the longer end of the Treasury market.

Treasury financing requirements also remain substantial. The US Treasury expects to borrow $739 billion in privately held net marketable debt during the July-September quarter, followed by another $628 billion during October-December.

Mustafa O. Pasha, Executive Director and Chief Investment Officer at Lakson Investments, said the pressure on US Treasuries reflected the interaction of monetary and fiscal risks rather than interest-rate expectations alone.

“The market is having to absorb the prospect of tighter monetary policy at the same time as very large fiscal deficits and debt issuance keep adding to Treasury supply. When inflation uncertainty remains elevated, investors naturally demand greater compensation for holding longer-duration government securities, which translates into higher long-term yields,” he said.

Pasha said the implications extended well beyond the United States because Treasury securities serve as the benchmark for global risk-free interest rates.

“When US Treasury yields move higher, the repricing travels across global financial markets. Emerging-market sovereigns and companies generally have to offer a premium over those rates, so an increase in the underlying US benchmark can raise financing costs even if their own domestic fundamentals have not changed materially,” he added.

Treasury has already taken steps to support market liquidity at longer maturities. From September 9, it increased the maximum size of liquidity-support buybacks for securities in the 10-to-20-year and 20-to-30-year sectors from $2 billion to at least $4 billion per operation.

The measure is intended to improve liquidity in longer-dated securities rather than alter the underlying fiscal position. The persistence of elevated yields indicates that investors are weighing broader concerns surrounding inflation, government borrowing and the future supply of Treasury debt.

For Pakistan and other emerging economies, the increase in US yields matters because Treasury securities provide the benchmark over which sovereign-risk premiums are added when governments borrow internationally.

Dr S. M. Naeem Nawaz, economics professor at the Pakistan Institute of Development Economics and former Fiscal Director at the Finance Division, said persistently higher US yields could complicate efforts by emerging economies to return to commercial international borrowing.

“For Pakistan, the relevant issue is not simply what happens to the Federal Reserve’s policy rate. The 10-year US Treasury yield is an important international benchmark, and when that benchmark rises, countries such as Pakistan face a higher starting point for external commercial borrowing before their sovereign-risk premium is even added,” he said.

Nawaz said this made the timing and structure of any return to international capital markets increasingly important.

The immediate focus is on the Federal Reserve’s September 16 policy announcement and updated economic projections. The meeting will include a fresh Summary of Economic Projections, giving investors new guidance on policymakers’ expectations for inflation, economic growth and the future path of interest rates.

But the pressure on the bond market extends beyond a single Fed decision. With inflation remaining above target, federal debt exceeding $40 trillion and Treasury financing requirements running into hundreds of billions of dollars each quarter, investors are increasingly weighing both the direction of monetary policy and the compensation required to hold an expanding supply of long-duration US government debt.

Credit: INP-WealthPk