By Ann Saphir and Howard Schneider
JACKSON HOLE, Wyoming (Reuters) – It’s no safer than a bund. Or gilt. Or OAT.
Long referred to as the “safe haven” securities of the world, the behavior of the US Treasury during and after the COVID-19 pandemic has given rise to this label, showing that it is no different from the debt issued by Germany, England, France, or even large companies.
These are the key findings of new research presented at the Kansas City Fed’s annual research conference in Jackson Hole, Wyoming. It examines changes in the behavior of investors at a time that raises questions about the “exorbitant privilege” the US government has long been happy to borrow widely in the global market even as the Federal budget gap is increasing.
It’s a timely question as the growing deficit appears to be a certainty no matter who becomes the next US president.
Roberto Gomez-Cram from New York University, Howard Kung from London Business School and Hanno Lustig from Stanford University also expressed the claim that the Treasury market was dysfunctional at the time – as the Federal Reserve asserted when it launched large bond purchases – or only rationally determined the risks unfunded spending shocks, then prepare to respond to health emergencies.
“In response to COVID, US Treasury investors appear to have shifted to a risky debt model when pricing Treasurys,” New York University’s Roberto Gomez-Cram, London Business School’s Howard Kung and Stanford University’s Hanno Lustig wrote in the paper. “Policymakers, including central banks, should take these changes into account when assessing whether the bond market is functioning properly.”
Researchers look at the behavior of Treasuries securities at the end of the pandemic in 2020, when yields are higher not only for US debt but for bonds issued by countries around the world.
They found that investors did not, as happened in previous episodes of global financial stress, pile into Treasuries and increase their value. Instead, investors mark up Treasury securities, as they do for bonds from other countries.
Meanwhile, the US Federal Reserve responded to the rise in US Treasury yields as if it were the result of market dislocation, they said, buying bonds to bring back to the debt market usually the most liquid in the world as they were during the Global Financial Crisis.
“In a risky debt regime, valuations will respond to government spending shocks, which may lead to large yield changes in the bond market,” the researchers said, noting that they found large market movements on days when fiscal stimulus was announced.
“In this environment, large-scale asset purchases by central banks in response to large increases in government spending have unintended public finance implications,” he wrote. “These measures, which provide temporary price support, undermine value for taxpayers but subsidize bondholders” and may encourage the government to assume its true fiscal capacity, he wrote.
PUSHACK
The paper drew pushback from its audience, including Treasury Department officials and others who said it had to deal with the uncertainty surrounding the pandemic, the fact that the hundreds of billions of dollars in fiscal response to the crisis were funded without a hitch, and more recently. US bond yields have fallen despite persistent deficit spending.
The paper did not reflect the “uncertainty of the episode,” US Treasury Secretary for Domestic Finance Nellie Liang said in remarks from the conference floor.
He noted that “by passing the Cares Act there is over a trillion dollars in debt…
(Reporting by Ann Saphir and Howard Schneider and Dan Burns; Editing by Chizu Nomiyama)
