Is US Government Debt Getting Riskier?

The price of 30-year US Treasury debt has been increasing, with various factors contributing to this trend. One possibility is that investors are demanding higher rates due to concerns about future inflation or the growing risk of US government debt. Another explanation could be the surge in productivity from advancements in information technology, which is raising capital demand and subsequently driving up interest rates.

These rising interest rates are not unique to the United States, but rather a global phenomenon that warrants a global explanation.

Hanno Lustig argues that risk is the key factor in this situation in his book "America's Risky Debt: What Markets See That Policymakers Don't." He points out that if US Treasury bonds are considered safer than other investments, the government should be able to offer lower interest rates compared to other borrowers. However, this pattern has changed in recent years, as investors now view US Treasuries as more risky than alternative assets.

For instance, some major US companies, such as Microsoft and Johnson & Johnson, have been able to borrow long-term at lower rates than the US government.

Additionally, there has been a shift known as "flight to safety," where investors move towards safe assets like US Treasury bonds during times of falling stock prices or rising risks in other markets. This phenomenon also suggests that the returns on stocks and US Treasury bonds are now moving in tandem, as expected when two assets are exposed to similar risks.

In recent times, central banks' managers have been allocating less than 70% of their foreign-exchange reserves to US Treasuries, with a growing preference for foreign G10 bonds instead. Furthermore, the US government has been increasingly relying on shorter-term borrowing, which exposes it to fluctuations in short-term interest rates.

A concerning trend is that a larger share of US Treasury debt is now being held by hedge funds, which use this debt to execute various strategies with short-term time horizons. This type of investor differs from traditional long-term bond purchasers like life insurance companies. As more investors demand Treasury debt, the interest rates on these bonds could rise further.

Lustig suggests that the Federal Reserve has been inadvertently contributing to the lowering of interest rates on Treasury borrowing by intervening in the bond markets. He advocates for the Fed to step back and allow interest rates to reflect the true risk associated with US government debt. Despite Lustig's evidence not indicating an imminent catastrophe or crash in US Treasury debt, his findings highlight yellow warning signs in global financial markets regarding the rapid accumulation of US government debt.