A Late Night Note on Treasury Notes

Well, technically a note on a Treasury bond, the 30-year Treasury bond in particular.  If you hold a bond for 30 years, you would like to know that the interest rate on the bond is going to exceed the rate of inflation by some margin.  It has to, because otherwise you are double losing purchasing power–once because every dollar you receive in interest payments has less purchasing power, and big-time at maturity, when the face value of that bond will be severely eroded in purchasing power.  Assuming of course that the government you bought the bond from can even pay back the principal when it does mature.

For decades and decades the US government has enjoyed extremely low interest rates largely because buyers prized the certainty that they would get their money back and that the US would not have extended periods of very high interest rates and/or inflation.  Both are now called into question.  Our debt level is bad enough, but even in good economic times we are adding to that pile of debt at an astounding rate.  The current run rate on interest payments is over a trillion dollars.  We are in essence borrowing money to pay the interest on the money we borrowed before.

People think that the recent rise in interest rates on US Treasury debt was largely due to inflation.  It was part of the explanation, but not all by any means.  And that should terrify us.  The real reason is that borrowers are looking at the fiscal situation in the US and our political incompetence and our lack of urgency in addressing the problem, and are seriously wondering if there is principal repayment risk.  And the sheer size of our debt issuance is causing supply and demand issues which are driving up the price–interest rates are the price the government has to pay to get someone to buy its debt.  There aren’t enough willing buyers at lower rates, so the rates have to increase to offload the debt.

So it doesn’t matter what happens with inflation, interest rates will stay high because they are all pegged to what happens with the rate on US debt.  And that rate is unlikely to shrink significantly no matter what the Federal Reserve does.  The longest maturity, the 30 year bond is where we see the effects most clearly.  And today a disaster of a 30 year bond auction occurred.  The interest rate at which the notes were purchased was far higher than the government had listed them at.  And even then, the Treasury couldn’t get buyers.  The private dealers who handle the issuance for Treasury were stuck with a whopping 25% of the bonds–couldn’t find buyers for them.  As usual, Zero Hedge has more on this pathetic turn for the worse.  It isn’t going to get better until we end the deficits and actually reduce the debt, and along the way, ban the Federal Reserve from buying debt to prop it up.  (ZH Post)