March 31 (Reuters) – Inflation risks have pushed Treasury yields higher since the US-Iran conflict fueled energy prices. Now another threat to the health of the market will emerge: the cost of extended conflict.
Wall Street continues to expect the war to end soon, easing pressure on oil prices and the US economy. However, some analysts are raising the bar for expanded war-related defense spending, tax refunds and the potential impact of a severe economic downturn. They say it could become a problem for markets that have recently become bond-friendly, with the S&P US Aggregate Bond Index returning -0.6% so far in the first quarter.
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For example, BNP Paribas expects that the US deficit will remain below 6% of GDP over 2026 and 2027. However, factor in additional costs, and “you get from a deficit of less than 6% to something closer to 8% or even higher,” said senior economist Andrew Hu. That is not the trend that investors want to see.
IMAGES OF INTEREST
The bond market’s strongest sell-off so far has been concentrated in short-term yields, reflecting fading hopes of a near-term rate cut by the Federal Reserve. But longer-term yields have also risen, with the 10-year Treasury near 4.5% for the first time since last summer and other Treasury auctions this month drawing weak demand.
“All these small costs seem to be adding up,” said Bill Campbell, portfolio manager at DoubleLine Capital.
The financial position of the US was already stretched before the first operation of the US in Iran on February 28. The national debt has reached a record of $ 39 trillion, and annual interest payments are expected to reach $ 1 trillion this fiscal year.
NOT STEPPED UP TO
Markets so far do not expect major changes in the US fiscal outlook.
BNP’s Husby said the markets can only wait for the real rules to be in place before taking strong action. “There is no major financial risk being bought right now,” he said.
Dirk Willer, head of capital and asset allocation strategy at Citigroup, said the biggest risk is that the Federal Reserve will not be able to cut rates due to inflation as funding costs rise and the Fed wants to reduce the size of its balance sheet.
Then, “you could also see that the word of money is coming back on a bigger scale.”
ADD THEM FIRST
Near-term threats could be a Fed rate hike and rising political risk.
Robert Tipp, chief investment strategist and head of global funds at PGIM Fixed Income, warned that “the other shoe will drop if growth continues and inflation remains high and it looks like the US will be biased towards rate hikes or rate hikes this year.”
Christian Hoffmann, head of fixed income at Thornburg Investment Management, said years of economic turmoil that ultimately appeared manageable had trained investors to be passive – a pattern that may last until something catastrophic happens. “We may be on the cusp of that right now,” he said.
If long-term yields continue to rise, the main response of the Treasury may be to change its supply policy. DoubleLine’s Campbell said the 30-year yield of 5.25%, up from 4.95% recently, “will be a big problem” and could cause the government to reduce long-term lending in favor of short-term debt.
Mike Cudzil, a portfolio manager at PIMCO, sees the oil shock eventually slowing growth, preventing rate hikes and allowing the Fed to taper later this year – reducing yields. PIMCO has been increasing long-term debt in developed markets as a result.
Reporting by Karen Brettell; additional report by Vidya Ranganathan; edited by Colin Barr and Anna Driver
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