NEW YORK (Reuters) – Growing concerns among bond investors over U.S. government spending and its ballooning budget deficit are contributing to a massive sell-off in sovereign bonds that has sent Treasuries prices to their lowest level since 17 years.

“Bond vigilantes,” who punish profligate governments by selling their bonds, were a feature of markets in the 1990s, when concerns about U.S. federal spending sent Treasury yields soaring to 8 percent.

However, the increase in the US government deficit and the massive issuance of debt to cover these expenses has worried investors and brought the concept back into focus.

Ratings agency Fitch recently downgraded the United States’ credit rating, forecasting that the US deficit would fall from 3.7% of gross domestic product (GDP) in 2022 to 6.3% this year, due to the Increased debt service costs, new spending and falling federal revenues.

The Federal Reserve’s restrictive path has been the main catalyst for rising yields, but market participants attribute some of the fall in longer-term securities to investors worried about increased spending.

The yield on 30-year US Treasury bonds reached 5% on Wednesday, for the first time since 2007, before stabilizing.

“If public spending does not decrease now, the scale of the deficits in the event of a new recession raises questions, in the context of a significant supply (of Treasury securities), notes Gene Tannuzzo, global bond manager at Columbia Threadneedle.

Fiscal concerns have increased since the summer, when the Treasury announced plans to increase debt issuance.

According to estimates from the Apollo group, the volume of Treasury auctions will increase on average by 23% in 2024, all maturities combined. At the same time, the Fed is continuing its “quantitative tightening” by reducing the size of its balance sheet, which has become colossal with the massive purchases of securities made in 2020.

The federal deficit increased 156% in 2023 due to lower government revenues from fewer capital gains and wage premiums, as well as sharp increases in tax refunds, the Treasury Department said . Government spending increased by 10% during the same period, due to increased social security payments and debt-related spending.

“Interest costs alone are increasing at a rate that is unsustainable,” said Jake Remley of Boston-based asset management firm Income Research and Management.

Strategist Ed Yardeni, who coined the term “bond vigilantes” in the early 1980s, hit the nail on the head.

“Bond vigilantes have challenged (Treasury Secretary Janet) Yellen’s policies by driving yields to levels that threaten to create a debt crisis,” he said in an opinion piece published Wednesday by the Financial Times. “In this scenario, high yields crowd out the private sector (from capital markets) and trigger a credit crunch and recession.”

Bond investors forced a policy U-turn in the UK last year after a tax cut plan sent borrowing costs soaring, showing that bond vigilantes remain a force to be reckoned with count.

However, not all investors believe the vigilantes will be able to move the $25 trillion Treasury market.

Famed bond investor Bill Gross, co-founder of PIMCO, said bond vigilantes will have only a limited impact, given the Fed’s larger role in markets.

Bond investors “are pretty helpless pawns in this interest rate chess game,” he told Reuters by email. “The powerful kings (the Fed) and queens (the Treasury) control the chessboard through inflation and the huge supply of Treasuries, which could lead to checkmate in the event of higher yields and lower stock prices.

Greg Whiteley, portfolio manager at DoubleLine, believes that concerns over rates, rather than Treasury issuance, are the main driver of the price fall. According to him, some fund managers wait for a peak in returns before intervening.

“The government’s finances are a mess, but that’s not the main reason for bond sales right now,” he said.

The recent decline has brought yields back to pre-financial crisis levels, which has increased the appeal of bonds overall and supported performance for investors, said Robert Tipp, chief investment strategist and head of global bonds at PGIM.

(Report by David Randall, Davide Barbuscia, Corentin Chappron, edited by Blandine Hénault)

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