NEW YORK (May 27): Investors are bracing for a flood of US government debt issuance that over time could dwarf an expected rally in bonds, as they see no end in sight for large fiscal deficits ahead of this year’s presidential election.

While bond markets so far this year have been driven mostly by bets on how deeply the Federal Reserve (Fed) will be able to cut interest rates, fiscal concerns are expected to become more prominent as the Nov 5 election nears. Analysts and investors say a reduction in deficit spending does not appear to be a policy priority for President Joe Biden and Republican challenger Donald Trump. Both candidates’ teams dispute this notion.

Some investors have already started to allocate funds in ways that would avoid losses if Treasury yields, which move inversely to prices, start surging because of supply and demand imbalances. Others are concerned that uncertainty over just how much debt will be needed for deficit spending could end up destabilising the US$27 trillion (RM126.91 trillion) Treasury market, the bedrock of the global financial system.

“If we take a step back away from the Fed and away from the next six months where we could still get substantial rate cuts, supply numbers are not healthy,” said Ella Hoxha, head of fixed income at Newton Investment Management, who favors short-term maturities in Treasuries.

Benchmark 10-year Treasury yields, now at around 4.4%, could go up to 8%-10% over the next several years, she said. “Longer term, it’s not sustainable.”

So-called bond vigilantes — investors who punish profligate governments by selling their bonds — made a comeback last year, pushing 10-year Treasury yields to 5% for the first time in 16 years, but concerns over growing US debt issuance subsided after the Treasury Department in November slowed down the pace of increases.

In its latest refunding announcement this month, the Treasury Department said it plans to keep auction sizes steady over the next several quarters. Still, larger auctions for long-dated debt are expected already next year, analysts have said.

Federal debt held by the public could grow by US$21 trillion to US$48 trillion by 2034, according to the Congressional Budget Office. Meanwhile, traditional sources of demand for US government bonds are lagging. Foreign ownership is not keeping up with the growing size of the market and the Fed keeps shrinking its bond holdings.

“One of the things we’ve been talking a lot about internally is not just the supply but the demand,” said David Rogal, managing director and a member of the multi-sector team in BlackRock’s global fixed income group.