US Rates Strategists at TD Securities (TDS) express their concerns over ballooning US deficits and their impact on the Treasury market.

Key quotes

“While Treasury is likely to hold auction sizes steady starting in May, investors remain concerned about the long-term US deficit trajectory. We believe it would take a combination of stronger economic data and a refocusing of market attention on the deficit outlook to produce a repeat of the 2023-style bear steepening in Treasuries.”

“US deficits are on one of the worst trajectories on record and are set to deteriorate further as the 2017 tax cuts are likely to be renewed next year.”

“The reinstatement of the debt ceiling in early 2025 should ensure that the budget and debt ceiling are politically coupled once again. Next year's negotiation is likely to be one the most contentious showdowns since 2011, and we see a risk of yet another downgrade to the US credit rating.”

“The ongoing rise in deficits and declining dealer balance sheet capacity have led some investors to conclude that the Fed would intervene in markets if liquidity conditions deteriorate sharply. However, we believe the bar for the Fed intervention is quite high, and it would take a true shock for the Fed to step in.”

“The Treasury market is likely to remain focused on inflation and growth in the near term. However, rising deficits should continue to push term premium higher, the curve steeper, long-end swap spreads tighter, and keep real rates elevated.”

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