Last updated: February 9, 2009 6:37 pm

US Treasuries

What is happening in the market for US government debt? In spite of a succession of progressively worse economic indicators, both in the US and abroad, yields on US 10-year government bonds passed back through 3 per cent on Monday. The move continues a remarkably swift correction since yields fell to a postwar low of 2.08 per cent in December, and by pushing up borrowing costs threatens to offset attempts by the Obama administration and the Federal Reserve to stimulate the economy.

Part of the move represents concern about the amount of supply on the way. The government needs to raise $2,000bn in new debt this year to fund spending, with a record $67bn in issuance set for this week. The appetite of foreign buyers for Treasuries remains uncertain, particularly as falling levels of trade are causing growth in foreign exchange reserves to slow among typical buyers of US debt.

Even so, expansions in supply have not been linked historically to big movements in bond prices. Demand for Treasuries naturally tends to rise in times of recession. There have been other factors at work. A small increase in risk taking has seen some movement into high-quality corporate debt, with issuance here rising strongly in January as companies seize the opportunity to raise debt and refinance while credit is available. Meanwhile, the credit crisis has resulted in bond traders being given less capital to play with. This has meant that arbitrage opportunities are not being exploited, and that dealers have less money to hold in bonds.

The bigger question is whether this latest move represents the first stirrings of inflationary fears or is simply a temporary pullback from what has been a huge bull run for bonds. However, the Federal Reserve has repeatedly indicated a willingness to buy Treasuries if necessary. The bond market appears to be testing the resolve of Ben Bernanke, the Fed chairman, to make good on his threats of intervention.

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