The recent rally in government bonds globally may be nearing its eleventh hour after a historic flight to safer assets pushed yields down to their lowest since World War II.
But the moment the proverbial clock will strike midnight is the multi-trillion dollar question for bond investors.
A massive tide of bond issues that the United States and other major governments are making to finance the rescue of the global banking system and to fund economic stimulus packages will ultimately overwhelm these markets, sending yields spiking up as swelling supply cheapens prices, bond analysts worry.
"The iron law of fiscal expansion means government issuance cannot be revised down. The bonds will be sold, the question is (at) what price,'' said Meyrick Chapman, rates strategist with UBS in London.
Timing is everything for fund managers still betting government debt yields can go lower, or for those temporarily hiding out in those markets and waiting for treacherous selloffs in corporate debt and stocks to abate.
Once the credit crisis eases, allowing lending to flow more smoothly among banks and corporate debt markets and the downtrodden global economy shows signs of bottoming out, then investors could desert government debt in their droves, triggering a vicious sell-off.
"Somewhere along the line, and I am not smart enough to tell you when, some of this massive amount of money will start moving back into other types of instruments,'' said Leonard Santow, managing director of economic and financial consulting firm Griggs & Santow in New York and a former financial economist at the Dallas Federal Reserve.
"Come on: three basis points on Treasury bills,'' said Santow. "If that's the way things are forever, we have real problems, so somewhere here, whether it's three months or six months away, those rates will start to be more normal. That will obviously push rates up along the curve to something half-way reasonable,'' he said.
While the US three-month Treasury bill rate has fallen to near zero, as panicked investors flee equity markets for the shelter of ultra short-dated government instruments, the benchmark 10-year US Treasury note yield slipped this week just below 2.99%, the lowest in five decades.
But a year from now the 10-year note's yield will have jumped to between 4.25% and 4.75%t, Santow estimates.
"A very strong case can be made that Treasury rates will have to go up,'' as issuance inundates the pool of $US4.9 trillion ($7.5 trillion) Treasury securities outstanding, Santow says.
He expects between $US1.75 trillion and $US2 trillion of US government debt supply in the remainder of the fiscal year through September 2009, with between $US600 billion and $US700 billion in Treasury bills; the rest in notes and bonds.
In the euro zone, sovereign debt issuance is likely to run to at least 700 billion euros ($1.37 trillion) in 2009. In the UK, the Debt Management Office plans to increase sales of Gilts to a record 146 billion pounds ($338 billion) in the current financial year.
Dangers of success
Ironically the eventual trigger for a sovereign debt selloff that would plunge major govermments and corporate borrowers deeper into debt may be signs that today's bailouts costing trillions of dollars are starting to succeed in refloating the global economy.
But for now, government bailouts are still swimming against the economic tide. In what may prove to be the most severe global downturn since the Great Depression, hefty investment flows are unlikely to shift out of government debt and into corporate bonds anytime soon. Continued…
