US Treasury yields will be forced higher in 2019 due a series of factors creating a ‘perfect storm’ for the bond market… and investors aren’t ready, Michael Hasenstab has warned.
In his 2019 investment outlook, Hasenstab, CIO for the Templeton Global Macro Group, said that rate pressures will continue to underpin a challenging market for Treasurys.
‘Three key factors are lining up to drive Treasury yields higher, in our assessment: increased borrowing needs from the US government, a decline in Treasury buying from the Fed and foreign governments, and rising inflationary pressures,’ he said.
1. Fiscal deficit
Hasenstab noted that the fiscal deficit has expanded significantly under president Trump. Coupled with tax cuts and mandatory spending, that has increased the government’s borrowing needs.
‘Ongoing mandatory spending is projected to drive the fiscal deficit toward 5% of GDP, in our analysis. That increases the already high borrowing needs of the government,’ Hasenstab said.
2. Decline in bond buying
The reduction in Fed bond purchasing could cause a shortfall in the Treasury market, Hasenstab warned.
‘This leaves a large funding gap that will need to be filled by price-sensitive investors, who would need to triple their current levels of buying to fill the void. Less buying volume and more supply volume means that yields need to rise to find new clearing levels.’
3. Inflation rears its head
Hasenstab said that the first two factors alone would be hard enough to contend with. However, the rising spectre of inflation is also a consideration. Wage pressures have been rising on exceptional strength in the US labour market, along with a lack of skilled and unskilled labour in certain sectors.
‘The labour pools have been further constrained by restrictions on both legal and illegal immigration from the Trump administration,’ he said. Inflation is further propelled by late-cycle fiscal stimulus, deregulation and sector tariffs, which have raised costs to consumers.
Hasenstab added: ‘Given the current environment, we expect the Fed to continue hiking rates toward the neutral rate in 2019. Taken together, all of these factors form a perfect storm of rate pressures that we expect to drive Treasury yields higher in the upcoming year.’