uploads/2016/07/lower_budget_deficits_have_caused_a_dearth_of_bonds_2016-07-26_1024-1.jpg

Why Lower Fiscal Deficits Are Causing a Dearth in Bonds

By

Updated

There are other factors at work as well: a dearth of bonds, which is a function of both lower deficits and slower accumulation of credit by households, regulatory changes in the wake of the financial crisis and an aging population. The longer-term nature of these suggests ongoing pressure on yields.

Still, should economic data continue to improve, rates are likely to grind higher. And given the historically high duration on most bond indexes, even a modest rise in rates will impose some unpleasant losses on bond holders. But considering the surreal state of the global bond market, there is probably a limit to how far U.S. rates can rise. This low rate environment will be with us for some time to come.

Article continues below advertisement

Market Realist – Lower fiscal deficits are causing a dearth in bonds.

The graph above compares the government budget deficit and surplus in some major countries compared to 2009. As you can see, all major countries have reined in their deficits in the last six years. A fiscal deficit usually means the government has to issue bonds in order to bridge the gap.

This means there are fewer bonds in circulation compared to what it could have been if deficits were higher. Lower supply and higher demand for U.S. Treasuries (TLH) (TLT) has caused bond prices to surge and yields to fall.

All the factors cited in the series have caused yields to fall. Lower yields are here to stay since global growth is slowing. Volatility (VXX) is likely to rise, given the many uncertainties we face.

However, if US and global growths begin to show signs of improvement, the Fed could hike rates, causing yields to rise. However, any increase is likely to be mild due to the pressure of all the other factors.

Advertisement

More From Market Realist