US government debt trajectory to push long-term yields higher, says PIMCO

NEW YORK (Reuters) – Bond investors are expected to pocket higher debt payouts for holding long-term U.S. government debt due to its wide fiscal deficits, U.S. bond giant PIMCO warned on Thursday.

With apparently no end in sight for increases in government spending, concerns over U.S. debt sustainability will likely pressure government bond prices, pushing yields higher, PIMCO’s Head of Public Policy Libby Cantrill and Rich Clarida, global economic advisor, said in a note.

“With bond yields declining in recent months, it would appear that mounting U.S. federal debt isn’t at the forefront of investors’ minds,” they said. “Yet many clients have asked about the sustainability of the path of U.S. debt, whether politicians plan to do anything about it, and whether the ‘bond vigilantes’ will ultimately emerge to push borrowing costs higher.”

Bond investors’ concerns around U.S. government spending and budget deficit contributed to a sharp sell-off last year that pushed Treasuries prices to a 17-year low. So-called bond vigilantes – investors who punish profligate governments by selling their bonds, driving yields higher – were a feature of markets in the 1990s, when worries around U.S. federal spending pushed yields to 8%.

Rating agency Fitch last year downgraded the U.S. government by one notch and Moody’s (NYSE:) lowered its credit rating outlook on the sovereign, with both agencies citing worries over widening U.S. fiscal deficits.

“Absent changes to either mandatory spending or taxes, which we do not see as likely over the next several years, we believe that the market will eventually demand – and earn – a premium for holding longer-dated Treasuries,” said PIMCO. “This will lead to a steeper U.S. yield curve over time.”

A steeper yield curve is one where longer-dated bonds yield significantly more than shorter-dated ones.

Still, the global reserve currency status of the U.S. dollar is expected to limit how high yields will go, said Cantrill and Clarida. “Although the long-term debt trajectory is problematic, we don’t believe there will be a fiscal crisis in the U.S. anytime soon,” they said.