U.S. Treasury Bonds

Hasen Bao 25/02/2009 19:15

There are recent concerns that with all the bailouts of the housing market, the banking and auto sector, the issuance of debt by the U.S. government will augment. The major concern is; will there be enough people to purchase debts issued by the Treasury; and what will happen to the market interest rates if demand for Treasury bonds fails to catch up to its supply.

Treasury Bonds when compared with large/small cap stocks and corporate bonds are considered a much safer investment; it often generate a steady flow of fixed income over the lifetime of the bond, but comes at a much lower return. At times of financial duress treasury bonds are relatively attractive due to the plunging stock market and volatile commodity prices, investors are purchasing T-bonds to abate chances of defaults, but the Treasury is issuing debts at such a rapid rate that the market begins to mull the effects if demands for these bonds fall.

If supply has outstripped demand on Treasury bonds the most significant effect is reflected in a rise on the yields of these bonds, while the bond price plunge, (interest rates and bond price are negatively correlated; finally something from the textbook can be applied). With the rise of the bond yield; so will the market interest rate charged on loans, mortgages, credit cards etc. If this were to happen to the economy; the already depressed consumer spending will impair because high interest rates is basically an impediment for growth in businesses and consumer spending.

Some argues that high interest rates driven by a fall in bond price due to less demand is the result of investors shifting their money back into the stock market because the economy have began to recover. On the other hand; demands for bonds may slow down simply because there are just not enough people who want to purchase treasury bonds. There might still be hundreds of millions of people out there who do not own any Treasury bonds; but the supply of these bonds cannot incur in such a way that the government takes assumptions that everybody in America will at least purchase some of the bonds and a majority will own a bulk.

It is right for both bondholders and non-bondholders to be concerned about how the government’s financial stability plan will play out for their need for public debt and the ladder effects. To determine factors affecting the direction of the demand and supply of Treasury bonds; we should first and foremost be prognosticate of the direction of the board economy.

The first few questions I consider are ‘Is the current stimulus package enough?’ ‘Has all those who are incompetent in this recession received government bail out?’ ‘Will they need more bail out money?’ ‘How much more do I think the government is going to borrow before the economy reach trough?’ If the soothsayer inside of you has told you that the economy will enter the process of recovery next month than you will be able to derive the effects of the recovery on things like bond yields, bond price, demand and supply of the bonds, market yields etc.

I’m incompetent of knowing whether the U.S. Treasury has ever defaulted on any of bond’s coupon payments; but as the issuer of such massive amount of debts, combined with the pressures of reduced tax revenue and so many other areas that needs adequate government spending, this time, just maybe, to put it lightly a chance for interest payment delay or maybe, default.

Eventually the economy will recover from this devastating recession; and when it does I predict investors will rush into the stock markets like they always do. They will ask their mutual fund managers to readjust their portfolio to allocate a larger percentage in stocks and less in fixed-income bonds and the like. What I’m trying to point out is that the value of the bonds may deteriorate in both ways. But something might change in this process and I could be wrong.