Quick Bites: Bond Yields
Author and political advisor, James Carville, is quoted as once saying, “if there was reincarnation….I would like to come back as the bond market because you can intimidate everybody.” That is exactly what seemingly happened last week when President Trump announced a 90-day pause on tariffs for all but China. The change of tack coincided with US treasury yields selling off (ie yields higher), which followed an initial rally (yields lower) in the wake of Liberation Day when President Trump announced far more significant tariffs than expected.
A few questions arise in the aftermath of this development. Firstly, was it China that sold U.S. Treasuries? It seems intuitive to think that China may have responded to tariffs by dumping its holdings of U.S. Treasuries, given that a trade war of this magnitude leaves China with little (if any) incentive to purchase such securities to manage its exchange rate. While China may indeed have sold down its holdings, their influence on the market must be viewed in context. As shown in the next two charts, foreign ownership of U.S. Treasuries is relatively small at approximately $8 trillion (representing about one-quarter of all U.S. government debt), and China’s share within that is even smaller—just $750 billion. With an average daily turnover in the U.S. government bond market of around $1 trillion, it is difficult to attribute the sell-off in Treasuries solely to foreign investors.
Another question we have considered is: What do higher U.S. government bond yields mean for Australian government bond yields? Theoretically, the impact should be minimal. Australia is not engaged in a trade war with China, meaning it does not face the same inflationary pressures as the United States (however transitory those pressures may prove to be). Additionally, Australia does not have a significant debt problem, with debt-to-GDP below 50%. In contrast, U.S. debt-to-GDP exceeds 100%, and the cost of servicing this debt has ballooned to over $1 trillion per annum—a doubling since 2018.
Despite these notable differences, Australian government bond movements last week mirrored those of the U.S. That’s right—Australian bonds rallied and then sold off, just as occurred in the U.S. (see next chart). This correlation is not merely a short-term phenomenon; both markets have moved in sync over the past decade.
Does the above make sense? Perhaps historically. Low and contained inflation alongside manageable debt levels has prevailed across the entire developed world (ex Japan) for a prolonged period. But looking forward, it’s quite possible correlations break down and performance diverges. The backdrop of US fiscal sustainability headwinds and a trade war would suggest to us that Australian government bonds look a much safer investment than US bonds in the coming years. We would also add that the low value of the Australian dollar vs US dollar is another reason to be cautious on the outlook for returns from US Treasuries from an Australian investor’s perspective.
