US: Higher Treasury yields ahead - Wells Fargo

According to analysts from Wells Fargo, the supply-demand dynamics in the Treasury market may be changing and they see yields on Treasury debt rising in the next two years. 

Key Quotes: 

“Issuance of new securities by the U.S. Treasury Department has trended lower over the past six years as the federal budget deficit has narrowed. However, issuance is set to jump in the next two years as the deficit starts to widen again, and finding willing buyers for all the new securities may prove to be a bit more problematic than it has been over the past few years.”

“For starters, the Federal Reserve is effectively turning into a net seller of Treasury securities as it takes steps to shrink the size of its balance sheet. Foreign central banks, especially those in Asia, were quick to snap up Treasury securities when their currencies were experiencing upward pressure vis-à-vis the U.S. dollar and their FX reserves were swelling. We forecast that most foreign currencies will appreciate modestly against the greenback in coming quarters, which probably will lead to increased demand for U.S. Treasury securities from the foreign official sector, but a return to the rapid rates of reserve accumulation among those central banks that characterized the last decade does not seem likely.”

“That likely will leave the private sector, both domestic and foreign, as the principal buyer of U.S. Treasury debt. Demand for safe-haven assets spiked during the financial crisis, leading to a notable increase in demand for Treasury securities from foreign investors. Similarly, new regulations caused domestic banks to ramp up their purchases of Treasury debt, but those buying needs look to have been largely fulfilled. Short of another financial crisis, a surge in private sector demand for Treasury securities stemming from risk management considerations does not seem likely. So if demand for Treasury debt does not keep up with issuance, prices of Treasury securities will decline. Said another way, yields on Treasury debt must increase to clear the market. This conclusion is consistent with our forecast, which looks for yields on U.S. Treasury securities to rise over the next two years.”