The recently battered US Treasury debt market is unlikely to find any comfort when President Barack Obama releases his budget proposal for the fiscal year 2012 on Monday. It will be Obama's first budget since Republicans gained control of the House of Representatives last year, when the chorus of calls for reduced government spending turned much louder.
Following a sharp bond market sell-off since late last year, investors say depressed US Treasuries prices now reflect a wide belief that current levels of government borrowing are unsustainable. They also suggest investors have little faith that Obama's budget will offer any new solutions to reduce that debt.
"At the moment it is all just words and I don't think politicians have enough credibility that the market is willing to translate that into a trade," said Kim Rupert, managing director of global fixed income analysis at Action Economics LLC in San Francisco. "It is well understood that we have a pretty massive deficit problem and I don't know if Congress at this point, or Obama, have enough credibility for the budget to be market moving," Rupert said.
The main risk to Treasuries focuses on longer-dated debt, whose prices have been pulled lower, and yields higher, in part by worries over price inflation from a torrent of debt being issued by the government to prop up the economy. Further downward pressure on these longer maturities would widen the spread between yields on shorter and longer-dated debt along the Treasuries curve.
The most commonly used measure of the Treasury curve, the gap between two-year yields and 10-year yields, is trading near a record wide, or steep, level. Rising expectations the US economic recovery is gaining traction have played a role in the recent bond market sell-off but are not the only factor, said Michael Cloherty, head of US interest rate strategy at RBC Capital Markets in New York.
"The curve is still very steep - if it was solely a recovery story you would expect the curve to flatten tremendously because then people would say that Fed (monetary) tightening is coming soon," Cloherty said. The specter of the Federal Reserve raising interest rates from current ultra-low levels near zero would likely force short-term debt yields higher and flatten the Treasury curve.
"The fact that it has remained fairly steep suggests that there is a bit of (debt) supply concern out there," Cloherty said. The budget will be closely parsed in part to see if Obama embraces some of the recommendations that a deficit commission submitted last year to cut spending and raise taxes.
Investors will also want to know if Obama has any plans to go beyond his State of the Union call for $400 billion in savings by freezing many federal programs for five years. But, expectations are low. "When it starts getting implemented, or if something were to start being implemented, well then I will sort of buy into it," said David Ader, head of government bond strategy at CRT Capital Group in Stamford, Connecticut.
"I would also say that the Republicans undoubtedly have another say, and they are in control (of the House) so I do not take it that seriously," Ader said. If there is any one certainty about Obama's budget it's that it won't change much. Indeed, expectations are that US government budgets will not get the debt under control anytime soon. "The one big known variable is the persistence of large federal budget deficits," said Mark Vitner, senior economist at Wells Fargo Securities in Charlotte, North Carolina.