Investors seeking refuge from falling stock prices are unlikely to find a safe haven in U.S. Treasury bonds, which are poised to decline next year as the federal government ramps up debt issuance to fund a budget deficit swollen by President Donald Trump's $1.5 trillion of tax cuts.
Yields on 10-year U.S. Treasury notes, which move in the opposite direction of prices, are expected to climb to 3.35% in 2019 from about 2.87% currently, based on the average estimate of economists in a survey by data provider FactSet.
The trend could present an unwelcome surprise to investors accustomed to buying Treasury bonds during times when the stock market falls; historically the U.S. government's triple-A-rated securities are perceived as a safe place to park cash amid market turmoil. But with the federal budget deficit projected to rise by about 25% in fiscal year 2019 to $973 billion, the Treasury department will have to issue more bonds to cover the funding gap -- at a time when the national debt is already fast approaching a record $22 trillion.
With so much additional Treasury debt hitting public markets, economists say yields will likely have to climb to attract enough buyers.
"This year you don't have any more tax cuts, but you created the deficit that now has to get funded," said Steve Blitz, chief U.S. economist at the forecasting firm TS Lombard. "It'll require an inflow of capital and that means higher rates."
The 10-year Treasury yields already have more than doubled since mid-2016, driven by concern over the higher deficits as well as by the Federal Reserve's increases in short-term rates. An additional factor is rising consumer prices, which can push yields higher because investors typically demand more income from the bonds as compensation for any erosion of their principal due to inflation.
What's more, foreign investors, governments and central banks have dramatically slowed their purchases of U.S. Treasuries. After more than doubling their holdings to about $6.2 trillion from 2008 through 2016, foreign ownership of Treasuries has mostly held steady at that level since.
And the Federal Reserve, under a plan to normalize monetary policy following the unprecedented actions taken to revive markets following the financial crisis of 2008, has been letting roughly $30 billion a month of its Treasury-bond holdings mature without reinvesting the proceeds in new government bonds. That's another $30 billion of bonds per month the Treasury must find buyers for in global markets.
The central bank's "redemptions suggest that Treasury auction sizes will need to rise over the next few years," the government said in a recent report.
Trump and Treasury Secretary Steven Mnuchin have pledged that the deficit will shrink as the tax cuts pay for themselves - essentially stimulating economic growth to the point where the government becomes flush with new tax revenue.
But the Congressional Budget Office projects that the federal deficit will eclipse $1 trillion in fiscal 2020 and climb every year afterward, reaching $1.5 trillion in fiscal 2028.
"I would not be surprised to see 10-year yields pushing to 3.5% or even higher by end of 2019," said Tony Bedikian, head of global markets for Providence, Rhode Island-based Citizens Bank.
Jamie Dimon, CEO of JPMorgan Chase & Co. (JPM) , the nation's largest bank, has said 10-year Treasury yields should already be trading at 4%. At a conference in August, he said there's also a "higher probability than most people think" that the yields will top 5%, Bloomberg News reported at the time.
Deutsche Bank AG (DB) , the German lender, estimated in a Dec. 12 report that the Treasury's borrowing during the current calendar year will total $1.36 trillion, more than double the 2017 levels. Next year, the borrowings are expected to rise further, to $1.4 trillion.
Banks may absorb some of the new issuance of Treasury bonds, but there's still a gap of about $465 billion that will likely have to be purchased by households for the government to make ends meet, according to Deutsche Bank.
"If the American public is going to do it, it's going to want them at a much higher yield," said Dick Bove, chief strategist at Rafferty Holdings' Hilton Capital Management, who follows the Treasury market as part of his analysis of bank stocks. "I think they're probably buyers somewhere between 3.5% and 4%."
And even as a growing number of traders bet that the Federal Reserve early next year will slow or halt its pace of increases in short-term interest rates, some economists say that the central bank may not have a choice but to continue hiking -- due to nagging inflation fears. That in turn could push up 10-year Treasury yields, since investors usually demand a premium over short-term rates to effectively lend out their money for a longer period of time.
"The Federal Reserve's rate-hike program will drive long rates up well into next year," said Michael Underhill, chief investment officer of the money manager Capital Innovations LLC in Pewaukee, Wisconsin.
It's still possible that with global economic growth slowing, many foreign investors will continue to find Treasury bonds attractive as a safe haven, said Daniela Mardarovici, a portfolio manager of Bank of Montreal's $1 billion BMO TCH Core Plus Bond Fund. Their purchases should help to keep yields on the 10-year bond between 2.7% and 3.25%, she estimated.
"Sentiment will play a much larger role in 2019" than the supply of new bonds from the Treasury, she said.
Yet they might be ignoring the realities of the government's outsize borrowing, said Marc Goldwein, senior policy director at the Washington-based Committee for a Responsible Federal Budget, a non-partisan, non-profit organization that advocates for deficit reduction.
"For whatever reason, the rest of the world still has faith in the U.S. government, that we're going to do the right thing," he said.