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Will the United States Become a Bond Haven in 2019?

Stock Market News

December 2018

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Will the United States Become a Bond Haven in 2019?

Will the United States Become a Bond Haven in 2019?With Italian bond yields rising quickly from 2 percent to 3 percent since the middle of 2018, it begs the question if the United States will become a bond haven. There are many reasons why the United States Bond Market has the potential to became a refuge for many global investors.

According to a 2016 paper from the National Bureau of Economic Research, safety is in the eye of the beholder – in the case of the global markets, it's the investor. When there are global economic worries, the paper credits a "nowhere else to go" theory for investors that choose U.S. debt versus others. Along with a country's ability to handle its own debt, the National Bureau of Economic Research found that even if a country's “fiscal position deteriorates,” its debt is more attractive as long as the country's fiscal health is in better shape than others, relatively speaking.

Understanding How the United States' Situation is More Attractive Globally

Since virtually every country uses debt to run the government, they issue bonds in their respective currencies. The returns on bonds are the interest rates offered by the borrowing country to pay the borrower (either the domestic or foreign buyer of the debt). Looking at 10-year bonds is one way to evaluate interest rates among different countries, be it the United States, Italy, China, etc.

Understanding How Yields or Bond Interest Rates are Determined   

With Italian bond rates currently at 3 percent – up from 2 percent in about 6 months during 2018 – this has given many a cause for concern due to the rate of increase. Coupled with the Italian government's existing debt obligations exceeding its yearly economic output by more than 30 percent, compared to the United States’ debt obligations at about 100 percent of its current economic output, those looking to buy government debt would have a lower risk of not getting paid with the U.S. government issued debt.

When it comes to the global markets determining interest rates, there are two primary factors. The first is how much inflation is expected between purchase and redemption date. This is important because bond buyers want to know how much inflation will impact their investment. The second, and arguably more important, is what are the chances of the issuing government failing to repay its bond or debt obligations in the case of a default.

Understanding the Rise in Italian Bond Rates

While some economies across the world can and do print money to deal with paying off debt, Italy, as part of the European Union, cannot print additional Euros. While inflation is not a major fear for the Italian economy, the recent back and forth between the Italian government and officials from the European Union has raised concerns about excess spending and Italy’s ability to pay for it in the future. The proposal would reduce taxes and increase spending for the public and private sector investment. This is what’s adding to uncertainty about Italy's ability to service its debt, thus negatively impacting its 10-year bond rates – similar to what eventually happened in Greece.

Sources

https://www.nber.org/papers/w22017

Used the following PDF from that main site: https://www.nber.org/papers/w22017.pdf   

https://www.marketwatch.com/story/italy-bond-yields-jump-as-investors-brace-for-budget-clash-2018-10-08

https://tradingeconomics.com/italy/government-bond-yield

https://www.pbs.org/newshour/economy/todays-italian-bond-crisis-explained

https://www.reuters.com/article/us-eurozone-bonds/italian-debt-set-for-one-of-its-best-weeks-since-crisis-era-idUSKCN1LM10F

https://www.bloomberg.com/news/articles/2018-05-29/italian-two-year-bond-yields-climb-to-highest-level-since-2013

https://www.marketwatch.com/story/italy-bond-yields-jump-as-investors-brace-for-budget-clash-2018-10-08

https://www.cnbc.com/2018/10/05/italy-government-announces-brave-and-responsible-budget-2019plan.html

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These articles are intended to provide general resources for the tax and accounting needs of small businesses and individuals. Service2Client LLC is the author, but is not engaged in rendering specific legal, accounting, financial or professional advice. Service2Client LLC makes no representation that the recommendations of Service2Client LLC will achieve any result. The NSAD has not reviewed any of the Service2Client LLC content. Readers are encouraged to contact their CPA regarding the topics in these articles.

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