Bond investors are concerned about the financial woes of leading economies. Budget and debt disputes have cost even global benchmark issuers a great deal of confidence in recent months – at a time that promises to be critical for the government bond markets. "In view of the high level of refinancing requirements of governments worldwide, there will be increasing competition for capital between government issuers," predicts Axel Botte, senior market strategist at Natixis subsidiary Ostrum Asset Management.

In this competitive environment, even the status of being the deepest and most liquid capital market in the world is no longer enough to win over investors. At the beginning of November, primary dealers at an auction of thirty-year Treasuries were forced to take 24.7% of the issued bonds with a volume of 24 billion dollars onto their own books. The proportion of banks involved as dealers was thus twice as high as the average of the previous six months. Interest in auctions of ten-year US government bonds has also been exceptionally low recently.

However, the yield trend has hardly reflected structural demand problems since then. Although the current yield on thirty-year treasuries shot up following the botched auction in November, it has fallen significantly since then. The yield on the ten-year benchmark, which briefly exceeded 5% in October and was at its highest level since 2007, had fallen to below 4% by mid-December. The bond market rally was driven by the hope that the Federal Reserve will soon cut interest rates, after it had adjusted its inflation expectations downwards at its December meeting. The monetary authorities' interest rate projections now point to three rate cuts in the new year.

However, Federal Reserve Chairman Jerome Powell refuses to rule out further interest rate hikes. And probably more importantly, from the perspective of primary market participants: There is no change of pace in sight for quantitative tightening. Since the summer of 2022, the Fed has reduced its bond holdings from almost 9 trillion dollars to just over 7.7 trillion dollars at the last count. The competition for capital "is exacerbated by the fact that central banks are reducing their balance sheets", emphasises Natixis manager Botte. Jeffrey Kleintop, global chief investment strategist at US broker Charles Schwab, sees "massive budget financing challenges" as a result, which are also likely to play a role in the 2024 congressional and presidential election campaign.

The heated rhetoric ahead of the election in November poses further problems for the market, as government finances are one of the significant centres of conflict between Republicans and Democrats. Due to the dispute over raising the debt ceiling in Washington, the Treasury Department was practically unable to borrow money via new securities during the first half of the year. According to the Securities Industry and Financial Markets Association (SIFMA), the volume of issues across all maturities totalled more than 2.5 trillion dollars in both October and November. In the same months of the previous year, they totalled 1.3 and 1.6 trillion dollars, respectively.

The subsequent debt dispute is already impending, with the debt ceiling only being suspended until January 2025 as a result of a compromise reached in Washington in June – by then, the fronts between Democrats and Republicans are likely to have hardened even further as a result of the election campaign, according to political analysts. The following funding squeeze could then loom. The rating agency Fitch criticised the "erosion of the state regulatory framework" in the USA and downgraded the United States' credit rating from "AAA" to "AA+" in August. Moody's lowered its outlook from "stable" to "negative" in November.

This is a deterrent for foreign bond investors in particular – especially as important treasury buyers such as Japan's leading banks and life insurers are finding more attractive yields in the domestic market again. Speculation that the Bank of Japan will soon end its ultra-loose monetary policy is making yen currency hedging less attractive for market participants from Nippon. Strategists such as Schwab's Kleintop are therefore anticipating a large-scale and potentially rapid repatriation of capital by Japanese investors, who would have invested a total of more than USD 3 trillion in the US financial market.

According to Botte, certain issuers are likely to have serious problems tapping the market in this environment, especially if quantitative tightening continues. "Investors should keep a close eye on government bond auctions," emphasises the Natixis strategist. There is a risk of significant shortfalls in some countries. In order to attract more international investors following the increasing disappearance of central banks as buyers, many countries would have to offer significantly greater compensation for maturity and credit risks, i.e. a higher term premium.

According to Oliver Eichmann, Head of Rates Fixed Income for Europe, the Middle East and Africa, DWS favours short and medium-term government bonds in 2024. The asset manager even predicts significant price gains for these bonds: Yields are forecast to fall by 100 basis points for two-year T-notes and 50 basis points in short-term German bonds.

While the Treasury is struggling with a low order volume, particularly in its auctions for longer maturities, the German government can look back on a record year for issues "with very good investor demand", as Tammo Diemer, Managing Director of Deutsche Finanzagentur, recently emphasised in an interview with Börsen-Zeitung. The issue volume is expected to fall slightly in the new year compared to 2023 but will be well above pre-coronavirus levels.

However, investors are somewhat concerned about the political situation in Berlin. After days of negotiations behind closed doors, the governing coalition agreed on a budget for 2024 in mid-December. However, the preceding crisis – which came about after the Federal Constitutional Court overturned the reallocation of over 60 billion dollars in credit authorisations from the coronavirus era for climate protection – has raised doubts about the resilience of German fiscal planning. However, they are not as severe as those in Washington. In the US, Jan Viebig, Chief Investment Officer at Oddo BHF, sees no prospect of a necessary fiscal reform due to the polarisation in Congress. In the competition for capital, the Bund could, therefore, experience an appreciation simply because the most important global benchmark issuer is faltering massively. The eurozone's top dog could certainly benefit from this if investors look for alternatives in the international bond market.