The Budget Deficit and Bond Yields

There are a number of reasons why bond yields remain low in 2014, but one factor is likely the federal deficit picture this year.

 

On Wednesday the Treasury released the May monthly Treasury Statement.  The deficit in May came in at $130 billion, down from $138 billion in May 2013.  For the fiscal year through May the deficit was $436 billion compared to $626 billion for the same period last year.  The chart below shows the actual (purple) budget deficit each year as a percent of GDP as well as an estimate for the next ten years per the CBO.

 

Source: Calculated Risk

 

The 2014 deficit estimate is less than 3%. The decline in the deficit from almost -10% to under -3% would be the fastest decline since the demobilization following WWII.

We are seeing progress on two fronts. First, revenues are up. As Ed Hyman at ISI notes:

“Federal receipts through May have increased almost +45% from their recession low. Personal income and corporate profits are both up significantly, as are capital gains and, more importantly, tax rates. Receipts in May were up +9% year-over-year (see chart below).”

Source: ISI

 

Secondly, Federal spending continues to trend lower.  Outlays are down -4.7% year-over-year, as you can see below.

Source: ISI

 

Mandatory spending cuts are playing a large role in this, and the cuts are very evident when you look at the Federal government’s payroll. Employment has dipped sharply the last few years at the Federal level.

Source: ISI

 

What this all means is that the Treasury is issuing fewer bonds every month to finance itself. While the total stock of debt issued is huge (over $17 trillion on the latest reading), rates are set at the margin. Less supply, all things being equal, means prices go up and yields fall. A Deutsche Bank analysis noted that the net issuance of Treasury debt has fallen 59% so far this year. An RBS Securities report estimates that the demand for high-quality bonds for 2014 will amount to $1.2 trillion while actual net supply is roughly $600 billion.

 

While the supply picture is only one part of a complex puzzle, it is likely playing an important role in 2014 in setting bond yields globally.