Despite the high costs of the War on Terror, heavy consumer borrowing, and a recovery in the economy, new bond issues have been falling since 2003, as the graph shows. The four main segments of the bond market are Treasury securities (Table F209), agency securities (Table 210), municipals (Table F211), and corporate and foreign bonds (Table 212).

Supply and Demand in the U.S. Bond Market

The government crackdown on Fannie Mae, the leading issuer of agency securities, took a big piece out of the U.S. bond market.

(See: “Primary Market for Agencies Dries Up“.)

Rarely has the career of a single individual, in this case, Mr. Franklin Raines, had such a dramatic impact on the U.S. capital market.

The Treasury bond market has been driven primarily by government spending policies. Over the decade, as the graph shows, Treasury issues have varied from a high point to finance the War on Terror in 2003, to net redemptions in 2000, resulting from the Clinton budget surplus.

New issues of corporate bonds, which appear from the graph to have held steady since 2003, actually have been undergoing an internal dynamic, perhaps of long-term significance.

(See: “Corporate Bond Issues Hold Steady“)

The dominant supplier in this market has shifted from nonfinancial corporate business to issuers of asset-backed securities.

From this I would draw two conclusions:

1. The Federal Reserve Board has precious little control over either supply or demand for long-term bonds, and consequently, over long-term interest rates. It is the U.S. Congress that controls spending and taxation that results in issuance or redemption of Treasury securities. It is also Congress and the Executive Branch that cracks the whip on the institutions that issue agency securities. State and local governments control issuance of municipal bonds.

2. There has been an increase in demand for bonds, driven by a rising trade deficit, the needs of pension funds and insurance companies, and individuals moving out of equities into bonds as the population ages. On the other had, the supply of bonds in Q3 2005 was not much different than in 1998. This suggests an explanation not only for the long-term drop in bond yields , but also for the recent leveling of the yield curve.

(See: “Trade Deficits Have Depressed Bond Yields for Twenty Years.”)

(See: “Inverted Yield Curves and Logical Traps.”)

This entry was posted on Tuesday, February 14th, 2006 at 1:29 pm and is filed under Treasuries, Open Market, Agencies, Mortgages, Municipals, Corporate Bonds, Government Officials. You can follow any responses to this entry through the RSS 2.0 feed. Both comments and pings are currently closed.

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