Making sense of the forces driving global markets

By Jamie McGeever, Markets Columnist 

Investors' unease about holding long-dated sovereign debt was magnified by a soft 20-year U.S. Treasury note auction on Wednesday, which slammed the dollar and stocks, pushed long bond yields higher and steepened the U.S. yield curve. 

In my column today I take a closer look at the rising term premium on U.S. debt. How much higher can it go? More on that below, but first, a roundup of the main market moves.

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After a poor 20-year government bond auction in Japan on Tuesday, it was the turn of a weak sale of 20-year U.S. debt on Wednesday to cast a cold, dark shadow over world markets and put investors on the defensive.

The trouble is, when supposedly safe-haven sovereign bonds are at the root of the deepening market angst, the selloff takes on a more worrisome significance. And when it's U.S. Treasuries specifically, the cause for concern is even greater.

Wednesday's auction of 20-year notes, the first sale of U.S. government debt since Moody's stripped the US of its triple-A rating last week, drew softer demand than usual but what soured sentiment and risk appetite was the high yield investors demanded.

That was always going to be the case really - investors of all stripes from every corner of the world will buy Treasuries, the only doubt is the price. It was clearly lower than expected on Wednesday, and markets reacted accordingly.

Washington's fiscal profligacy remains a major source of anxiety for bond investors. Non-partisan analysts say President Donald Trump's tax-cut bill proposals will add between $2 trillion and $5 trillion to the $36 trillion federal debt over the next decade. 

The 20-year Treasury note auction provided fuel for the bond fire, but fixed income was already smoldering on Wednesday - long-dated Japanese yields were at record highs and figures showed UK inflation rose much faster than expected to 3.5% in April, the highest in over a year. 

Tariffs, monetary stimulus, rising debt levels, poor fiscal discipline, growing policy risk, sticky inflation and soaring inflation expectations - these are some of the reasons investors around the world are reluctant to go long 'duration', or buy long-dated bonds. It's a potent mix, and all markets are feeling the heat.

U.S. markets, in particular, are under pressure as the rest of the world reevaluates its holdings of dollar-denominated assets in light of Trump's global trade war and drive to upend the world economic order of the past 80 years. 

Steep declines in U.S. stocks, Treasuries and the dollar on Wednesday point to a nervy global session on Thursday.

Financial markets have had a fairly muted reaction to Moody's decision to strip the United States of its triple-A credit rating last week, fueling hopes that the action will do little long-term damage to U.S. asset prices, as was the case when the U.S. suffered its first downgrade in 2011. 

But given today's challenging global macroeconomic environment and America's deteriorating fiscal health, that may be wishful thinking. To monitor the impact in the coming months, a key indicator to watch will be the so-called 'term premium' on U.S. debt.

When Standard & Poor's Global became the first of the three major ratings agencies to cut America's top-notch rating in August 2011, there was little blowback because Treasuries were still widely considered the safest asset in the world. Demand for U.S. bonds went through the roof, despite S&P's landmark move, and yields and the term premium plummeted. 

That's unlikely to happen now.

In 2011, the U.S. debt/GDP ratio was 94%, a record at the time reflecting a surge in government spending in response to the 2008-09 Global Financial Crisis. But the fed funds rate was only 0.25%, and inflation was 3% but falling. It dropped to zero a few years later and did not return to 3% until the pandemic in 2020.

It's a vastly different picture today. U.S. public debt is around 100% of GDP and projected to rise to 134% over the next decade, according to Moody's. Official interest rates are above 4%, inflation is 2.3% but expected to rise as tariff-fueled price hikes kick in. Meanwhile, consumers' short- and long-term inflation expectations are the highest in decades. 

And while the $29 trillion Treasury market is still the linchpin of the global financial system, increasing U.S. policy risk is prompting the rest of the world to rethink its exposure to U.S. assets, including Treasuries - 'de-dollarization' is underway.