Soaring U.S. debt is causing Treasury bonds to lose their risk advantage over other securities, making it more expensive to borrow money, the International Monetary Fund warned.
Treasuries have long enjoyed the status as the world’s top safe haven asset. But annual budget deficits are now at $2 trillion, rapidly piling on to the $39 trillion national debt total with interest costs alone reaching $1 trillion a year.
The emergency lender pointed out that the spread between AAA-rated corporate bond yields and Treasury yields has compressed.
The IMF also said the international “convenience yield” of Treasuries—meaning their safety and liquidity premium—has actually turned negative recently.
“In other words, Treasuries now offer a higher yield than the synthetic-dollar equivalents for hedged G10 sovereign bonds,” the report said.
The erosion of U.S. debt’s risk advantage can also be seen in other areas of the bond market. While investors have balked at Treasuries recently, demand has surged for debt issued by sovereign, supranational and agencies (SSA) like the World Bank and the European Investment Bank.
And in the secondary market, SSA dollar bond yield spreads versus Treasuries have also fallen to a few hundredths of a percentage point recently.
At the same time that the supply of U.S. debt has exploded, demand has also shifted, with global central banks becoming less prominent buyers while hedge funds have taken on bigger roles.
On top of that, the Treasury Department has increasingly relied on short-term debt that needs to be rolled over more frequently, exposing it to sudden changes in market conditions.
“Hedge funds own a record-high 8% of US Treasuries, and with combined repo and prime brokerage borrowing exceeding $6 trillion, any forced unwind of these leveraged positions could send shockwaves through global fixed income markets,” Apollo Chief Economist Torsten Slok said in a note on Friday.
In the IMF’s view, the U.S. faces “inescapable” arithmetic and urged Washington to stabilize its debt trajectory by taking action on both its revenue as well as expenditures, including entitlement programs.
“The window for orderly fiscal adjustment is narrowing,” the IMF said. “Advanced economies with large debt loads need concrete, well-sequenced consolidation measures, not aspirational medium-term targets.”
