U.S. government and corporations aren’t betting on rates rising much higher
The U.S. government and American corporations don’t appear to be locking in low borrowing costs even as the Federal Reserve dials up interest rates, a sign that the two largest contributors to the economy’s debt binge aren’t anticipating rates drifting much higher from where they presently sit.
The federal government’s recent issuance of short-dated Treasurys, and corporations’ borrowings recently have leaned toward floating-rate debt at the expense of fixed-interest bonds, says John Lonski, chief economist for Moody’s Capital Markets.
“Apparently, the U.S. government senses no pressing need to rush out and lock in recent fixed-rate borrowing costs of between roughly 2.5% and 3% for Treasury notes and bonds,” said Lonski, in a note published Thursday.
That’s even as the policy-setting Federal Open Market Committee on Wednesday signaled that consensus forecast for the fed-funds rates rose from a total of three this year to four, as indicated by the central bank’s so-called dot plot, senior Fed officials’ projections for future interest rates. The dot plot was raised 30 basis points to 2.4% for the end of the year, and to 3.1% by the end of 2019.
In theory, the expectation of a slightly more aggressive rate-hike path should compel borrowers to lock in lower borrowing costs for a longer period.
See: Fed lifts interest rates and aims for another pair of increases later this year
However, the Treasury Department’s debt management strategy runs against the Fed’s outlook for higher future rates. Bonds with maturities of a year or less, Treasury bills were issued to the tune of $535 billion for the 12 months ending in March, the biggest yearlong borrowing spree since a similar span in March 2009. The reliance on short-term debt to fund a yawning long-term deficit means the government’s interest expenses may ramp up if the rate hikes maintain their current pace.
Even after the recent climb this year, longer-dated yields for U.S. government paper are at historic lows. The the 30-year bond yield TMUBMUSD30Y, -0.38% trades at 3.025%, while the benchmark 10-year Treasury note TMUBMUSD10Y, -0.62% s at 2.898%. Between 2007 and 1990, the 10-year yield ranged between 4% to 8%.
“Those managing U.S. government borrowing effectively expect only a limited upside for short- and long-term U.S. Treasury interest rates,” Lonski wrote.
To be sure, the Treasury Department’s decision to issue a greater amount number of shorter-dated bills and debt instruments with maturities of a year or less, reflects in part the need to prevent the average maturity of outstanding debt issuance from rising. And some market participants say issuing paper with extended maturities to take advantage of the narrow gap between long-dated yields and short-dated yields would break the Treasury’s cardinal principle of “regular and predictable issuance.”
See: Don’t expect the Treasury to take advantage of a flat yield curve
Corporations aren’t borrowing at fixed-rates for long periods either. The ratio of borrowing by nonfinancial firms through loans and commercial paper has jumped to 48% for the year ending in March from 21% over the six years ending in March 2017. If rates continue to rise in the next few years, companies relying on short-term paper and floating-rate loans will see their interest expenses climb.
“Corporations are in no rush to lock in today’s still relatively low fixed-rate borrowing costs mostly because financial managers do not expect a long and extended climb by Treasury bond yields,” said Lonski. Yields for U.S. government paper serve as the benchmark for corporate borrowing rates.
Still, the vast majority of corporate debt was of the fixed-interest variety. Analysts at J.P. Morgan estimated 90% of the total $4.2 trillion debt held on the balance sheets of S&P 500 firms SPX, -0.10% featured a fixed-rate.
The sea change toward floating-rate debt is particularly prominent in high-yield issuers, debt-laden firms forced to borrow at higher interest rates and credit ratings that fall below investment grade.
From January to May, high-yield bond offerings slumped 20% year-over-year to $162 billion, while bank loans by high-yield issuers grew 2.4% year-over-year to $363 billion.
Refusing to lock in low long-term borrowing rates could imply that corporate and government bean counters see anemic growth and inflation in a few years, ultimately keeping interest rates and bond yields lower.
“Corporate finance officials may correctly sense that the ongoing climb by benchmark interest rates will eventually help to trigger a business slump that will ultimately drive the 10-year Treasury yield under 2%,” said Lonski.
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Sunny Oh is a MarketWatch fixed-income reporter based in New York.
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