Pressure on US to follow Japan in debt profile rethink

The Star

3 days ago

IN the face off between heavily indebted developed economies and increasingly wary investors, Japan has blinked first, announcing that it will reconsider its debt profile strategy amid plunging demand for long-dated bonds. The United States could soon follow.
Japan has the second-longest debt maturity profile of the Group of Seven (G7) nations, with an average of around nine years.
Decades of ultra-low policy rates allowed Tokyo to borrow huge amounts at very low cost across the Japanese government bond yield curve.
But in recent weeks, 30-and 40-year yields have soared to record highs, as appetite for long-dated paper at Japanese government bond auctions has dried up, a one-two punch that has forced officials to consider reducing issuance of long-term bonds in favour of short-dated debt.
Many of the debt pressures bearing down on Tokyo are also being felt in Washington.
The United States no longer boasts a AAA credit rating, following the downgrade from Moody's earlier this month, and the non-partisan Congressional Budget Office (CBO) projects federal debt held by the public will rise to a record 118.5% of gross domestic product (GDP) over the next decade from 97.8% last year.
Net interest payments will rise to 4.1% of GDP from 3.1%, it predicts.
Finally, there is Trump's tax-cut bill, which is projected to lump US$3.8 trillion onto the federal debt over the next decade, according to the CBO.
All this is creating understandable unease among investors, and even though foreign demand at bill auctions has remained high, on average, demand at bond auctions is the lowest in years. Treasury may be forced to grab a page out of Japan's recent playbook and shorten its maturity profile.
The United States has the shortest 'weighted average maturity' (WAM) of all G7 countries at 71.7 months, according to Treasury.
That's due to a mix of factors including rising deficits, the Federal Reserve (Fed) holdings of longer-dated bonds, and high liquidity and demand at the short end of the curve.
But this figure has rarely been higher on its own terms. While the WAM reached a record 75 months briefly in 2023 and was elevated during the post-pandemic period, it has otherwise rarely exceeded 70 months. Indeed, the average going back to 1980 is 61.3 months.
Shifts in Treasury's WAM over the past half century have largely been driven by the interest rate environment, economic and financial crises and investor preference.
While today's mix of market, economic and geopolitical trends is unique, it doesn't point to strengthening investor demand for long-dated bonds.
The decades before the pandemic – the period known as the 'Great Moderation' – were generally marked by falling interest rates, flattening yield curves, and weak inflation.
That era is over, or at least that's the growing consensus among investors and policymakers.
This largely reflects the belief that inflation pressures in the coming decades will be higher than those seen during the 'Great Moderation' – particularly given the move toward high tariffs and protectionism – meaning interest rates are likely to remain 'higher for longer'.
At the same time, America's apparent move toward isolationism and increased political volatility is apt to make global investors consider reducing their elevated exposure to dollar-denominated assets.
That could make it harder for the Treasury to borrow long term at acceptable rates.
These are broad assumptions, of course, and there are many moving parts. A sharp economic slowdown or recession could flatten the yield curve and spark an increase in longer-term issuance.
But the curve is currently steepening, and the United States 'term premium' – the risk premium investors demand for lending 'long' to Treasury instead of rolling over 'short' loans – is the highest in over a decade and rising.
This creates two problems. First, the Treasury may prefer to borrow longer term but not if yields are prohibitively high.
Second, even though the United States can borrow more cheaply at the short end when the curve is steepening, this increases the 'rollover risk', meaning the government becomes more vulnerable to sudden moves in interest rates.
T-bills' 22% share of overall outstanding debt is already above the Treasury Borrowing Advisory Committee's recommended 15% to 20% share, but it's hard to see that coming down much any time soon.
Morgan Stanley analysts earlier this month outlined a 'thought experiment' whereby low demand for notes and bonds could see the share of bills approach 30% by 2027.
Ultimately, Treasury supply will largely depend on investor demand. If primary dealers indicate a preference for shorter-dated bonds, the WAM will probably fall. Japan won't be the only developed economy rethinking its onerous borrowing plans. — Reuters
Jamie McGeever is a columnist for Reuters. The views expressed here are the writer's own.