Ultimately, the decision by the US Treasury to skew increases in issuance towards tenors which have less sensitivity to term premium increases, could backfire. The “meaningful deviation” from the historical recommendation for a 15-20% T-Bill share looks inspired: it is anything but. Shifting towards shorter tenors can work when interest rates are low, and there is a credible commitment to fiscal sustainability (‘cheap, but tight’). This is not the case today. Policy is ‘dear and loose’: interest rates remain high, and the US government continues to run a very stimulative fiscal policy. The only way to sustainably pin long-term rates is to tackle the underlying causes of the deterioration in the fiscal position. But this involves difficult political choices, and it has been clear for some time, there is little appetite for this in Congress.
If anything, we have entered an environment of structurally higher inflation, with excessively large government deficits. By slowing the slowing pace of coupon issuance, and initially achieving a big drop in Treasury yields (as seen over the past two days) the impression is given that that the Treasury has suddenly improved its fiscal position. The reality is very different. In effect, what the Treasury is signalling, is that deficits in excess of 6% are here to stay. Markets will eventually respond to this: demand for US Treasury long-term bonds will begin to fall behind supply once again. Long-term fiscal pressures from climate change, defence, cyber, continue to grow. It is very hard to see where deficit reduction will come from. Given this backdrop, the rally in Treasuries looks overdone. Inflationary pressures could re-emerge in 2024. Treasury yields could move higher once again.
Climate change is already having a detrimental impact on public finances. Delays to the clean energy transition will be catastrophic. Against this backdrop, the slide in alternative energy share prices is alarming. Costs have jumped, but prices agreed for the power generated by offshore wind farms have not. Developers have a clear message: prices will have to go up. The latest news from Orsted is another setback for President Biden’s aim to deploy 30 gigawatts of offshore wind by 2030, which is now out of reach. Siemens Energy last month issued its second profit warning in four months, and is looking for government guarantees. Once again, governments are on the hook here, asked to bear the risk.
