Treasury Yield Gap Keeps Growing

It is time for another update on the yield on U.S. debt, as reported by the Treasury.

The gap between long- and short-term debt continues to grow. Since last week, there has been a little bit of a rocky ride at the Treasury short end, but the long-term debt yields keep rising. Figure 1 reports, as usual, the average yield on the three longest bonds (blue; 10, 20 and 30 years) and the three shortest bills (red; 1, 2 and 3 months):

Figure 1

Source of raw data: U.S. Treasury

The growth in the yield gap is indicative of rising uncertainty in the sovereign-debt market regarding dependability of U.S. debt over the longer term. Plainly: investors are growing increasingly worried that the U.S. government will soon lose the ability to fully honor its debt commitments – in other words, pay interest on to its creditors. This concern did not rise from the current fiscal state of the U.S. government, which has been deteriorating for years on end; the one event that apparently caused the yield gap to grow was the Biden inauguration.

There is logic to this. Democrat control over both chambers in Congress and the White House not only gives them the ability to fast-track some spending that otherwise would get stuck in bipartisan negotiations, but it also emboldens them to pursue major, new spending that would be unthinkable if Congress was partisanly divided. This has apparently raised worries among sovereign-debt investors regarding – frankly – the basic solvency of the U.S. government.

As mentioned, the rate-gap evolved over the last week along the same trajectory as before, but there was one brief deviation from the trend. Mid last week, short-term yields made a little jump. On Thursday the one- and three-month rates increased from 0.03 to 0.04 percent, and on Friday the 2-month bill joined them.

Numerically speaking, these are very small changes, and they happen all the time on a daily basis, across the range of debt maturities. However, this jump was mirrored in long-term yields as well, with the 10-year bond rising from 1.38 percent to 1.54, the 20-year from 2.07 to 2.25 and the 30-year from 2.24 to 2.33.

This type of bump indicates that there was excess supply of debt across the market. Without correlating with the issuance date of new debt – or the recycling of old debt – it is reasonable to suggest that the Treasury last week got a glimpse of how the market will respond in the future if it keeps saturating the debt market without any changes to its long-term fiscal policy.

After the bump, long-term yields returned to their trajectory of steady increase. Short-term yields remain a bit bumpy, with the three-month at 0.05 percent and the other two at 0.03 percent. However, it is important to keep in mind that when we are dealing with such small numbers and with such a big market, daily swings in the yield mean less than they do when rates are higher (as on long-term debt).

Overall, the yield gap on U.S. debt continues to grow, indicating that the Treasury is losing the confidence of the market. Part of the reason for this is to be found in excessive deficit monetization, a practice that is clearly running low on fuel. Since the big money dump in early May last year, they have expanded M1 money supply by another 13.7 percent. The almost $2.2 trillion printed in the past ten months has been used to bankroll federal spending; in the first three quarters of 2020 the Federal Reserve bought $2.5 trillion worth of U.S. debt, almost exactly doubling its holdings:

Figure 2

Source: Federal Reserve

The message from the sovereign-debt market is clear: this monetization of the U.S. deficit is nearing its end. It is urgent for Congress to act in order to avoid a fiscal crisis; if they don’t, but instead continue to talk about even more monetized spending, the U.S. economy will inevitably be hurled into one of two very bad situations: a Greek-style crisis, or hyperinflation. Both would be disastrous, and both are still avoidable. But time is rapidly running out.

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