After moving to a 107-04 low in October 2023, the U.S. long bond futures recovered to a 125-30 high by late last year. The bond futures remained within that trading range through August 2024, when they broke out to the upside. The technical break could be significant, signaling higher bond prices and lower interest rates over the coming weeks and months. However, a bond market rally may not materialize, given several very bearish factors. The iShares 20+ Year Treasury Bond ETF product (TLT) tracks long-term U.S. interest rates, moving lower when rates rise and higher when they decline.
A technical move favors the upsideThe long bond futures were in a bearish trend, making lower highs and lower lows from March 2020 through the October 2023 low.
The ten-year chart highlights that the U.S. 30-year Treasury Bond futures have made higher lows and higher highs since the October 2023 low. In August 2024, the futures rose above the first technical resistance level at the December 2023 125-30 high, reaching 127-22 on Setpember 17 as the markets prepared for the first Fed Funds Rate cut in years.
The Fed cut short-term rates, and QT has slowed, taking pressure off interest ratesFed Chairman Jerome Powell did just a little hedging at the central bank’s annual Jackson Hole gathering when he said:
The time has come for policy to adjust. The direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks. My confidence as grown that inflation is on a sustainable path back to 2 percent.
The Fed had waited far too long to increase rates after calling inflationary pressures “transitory” in 2021 and early 2022. After rising from zero percent to a midpoint of 5.375%, the central bank was concerned about criticism that it has waited too long to ease monetary policy in response to price and employment data. The Fed trimmed rates by a higher-than-expected 50 basis points at the September FOMC meeting and has already slowed the pace of quantitative tightening, reducing the central bank’s swollen balance sheet. The more dovish monetary policy approach will likely support the bond market and cause longer-term rates to decline. However, the Fed has limited powers to control long-term rates, a function of market economic forces.
The bifurcation of the world’s nuclear powers and sanctions have made U.S. debt toxic for one high-profile former holderChina is the world’s second leading economy and has been a massive owner of U.S. sovereign debt for many years. The February 2022 handshake between the Russian and Chinese leaders, Russia’s invasion of Ukraine, Chinese plans for Taiwanese reunification, U.S. sanctions, and deteriorating relations between Washington and Beijing have had a significant economic impact. After reaching $1.3168 trillion in November 2013, Chinese holdings of U.S. government debt securities declined to $768.30 billion in May 2024.
The Chinese holdings have dropped to the lowest level in nearly a decade and a half. Sanctions on Russia and other Chinese allies have caused China to reduce its holdings. The bifurcation of the world’s nuclear powers has substantially impacted the economic landscape. If China continues to reduce its holdings, it could put downward pressure on the U.S. government bond market, pushing interest rates higher.
U.S. debt is at a level that threatens full faith and creditAside from Chinese U.S. bond holdings, the skyrocketing level of U.S. debt is another factor that weighs on bonds, increasing interest rates.
At nearly $35.39 trillion, U.S. debt erodes the full faith and credit of the U.S. government that issues legal tender and borrows in the sovereign debt markets. With the Fed Funds Rate at around 5%, it costs over $1.75 trillion to finance the debt, causing it to climb even if U.S. receipts and expenditures balance. The higher the debt level climbs, the greater the odds it will push long-term financing rates higher, as credit is critical for bond pricing.
The chart forecasts that U.S. debt will rise to over $54 trillion in a decade by 2034.
Expect volatility in the bond market over the coming weeks and months as the election will determine future U.S. policies The future of U.S. domestic and foreign policies is on the ballot in early November when the country will choose between a second Trump administration or a continuation of the policies of the past four years under Vice President Harris. Current forecasts are that either candidate will do little to stop the U.S. debt from climbing, but the issue could be if foreign policy will shift to open the door for other governments, including China, to purchase more U.S. debt to fund the growing debt. National security concerns suggest that cutting spending and increasing revenues is optimal for reducing debt and interest rates. However, in a turbulent world where military spending is rising, the debt level is unlikely to go down. A Harris or Trump administration will face significant economic issues given the debt level. Looking forward, the optimal economic plan will control the debt’s ascent. In the meantime, a Fed Rate cut and reducing QT will lower debt servicing costs. While Fed Funds Rate cuts over the coming months could cause a bond market rally in a kneejerk reaction, foreign relations and the massive U.S. debt level are the issues that will dictate the path of least resistance of long-term U.S. interest rates over the coming years.
On the date of publication, Andrew Hecht did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
