In order to finance a government’s spending habits, such as infrastructure, public transportation and lucrative political salaries, bonds are issued by the government in a foreign currency. Exchange rates and valuation rates can diminish the chances of countries repaying sovereign debt.
Many analysts, finance experts and contrarian investors have said that the world, including the United States, is in both a bond and sovereign debt market bubble. Essentially, the current market has been described as debt on debt on debt and that the money will never be paid back and economies will suffer from financial calamities unseen before.
According to successful mainstream investor Wilbur Ross, CEO of WL Ross, the sovereign debt market bubble will likely burst within the next two years, citing the 10-year U.S. Treasury yields hitting a record low in 2012 – it now stands at 2.62 percent – and the Italian and Spanish bonds following suit recently.
“I’ve felt for some time that the ultimate bubble, when we look back a few years from now, is going to be sovereign debt, both U.S. and other, because it’s way below any kind of reversion to the mean of interest rates,” Ross told CNBC. “If you look at where the U.S. 10-year had averaged over the 10 preceding years, it’s around 4 percent. If it reverts back to that level at some point, there will be terrible losses in the long-term Treasury market, and those will probably be accentuated in other areas of fixed income.”
With the Federal Reserve tapering its massive quantitative easing program – the Federal Open Market Committee (FOMC) confirmed another $10 billion reduction at a meeting last week – it was expected to have a significant impact on the debt market. However, Ross says this has not been the case.
“There’s been a shrinkage in mortgage-backed security issuance in the U.S., plus there’ve been fewer long-term Treasurys issued because the budget deficit has been smaller,” Ross added. “Those two combined have more than exceeded the amount of the tapering. That will no longer be true starting around December of this year.”
We reported last week that foreign holdings of U.S. Treasury debt reached a record $5.96 trillion with China and Japan holding a bulk of it: $1.26 trillion and $1.21 trillion, respectively. It has been stated by the Treasury Department that foreign demand for U.S. Treasury debt will remain strong for the rest of the year. The reason why is because there is a lot more borrowing certainty considering that Congress agreed to suspend the debt limit until March of next year.