RPT-COLUMN-US 're-industrialization' could haunt Treasuries: Mike Dolan

By Mike Dolan

LONDON, May 22 (Reuters) - Focusing on wary overseas holders of U.S. government debt often loses sight of more dominant domestic creditors - but both potentially cast a shadow over shaky bond markets.

As Moody's removed the U.S. Treasury's last remaining AAA credit rating last week, many pointed to the gigantic 14-year lag to S&P Global's decision to do so as a reason why it didn't really matter.

After all, dire warnings of fiscal oblivion in 2011 proved well wide of the mark in the interim.

Fiscal wobbles came and went, deficits climbed, total marketable Treasury debt outstanding trebled to more than $28 trillion and Washington's debt-to-GDP ratio climbed more than 30 percentage points to equal a full year's economic output.

Until recently at least, government debt costs over much of the intervening 14 years barely blinked.

Even now, at just over 2%, the real 10-year cost of Treasury borrowing US10YTIP=RR is basically where it was in 2008. Compensation demanded by investors for holding 10-year Treasury risk, the so-called "term premium", is still lower than it was when S&P cut the U.S. top rating in 2011. And nominal 10-year yields remained below mid-2011 levels for 11 years.

The main reason for the plain sailing was years of low inflation after the banking crash, near-zero interest rates from the Federal Reserve and other central banks around the world, and massive Fed bond buying into any economic shock - most recently the pandemic.

That saw government debt servicing costs as a share of GDP drop by almost a fifth in the five years after the Lehman Brothers bust.

But as Carlyle's Head of Global Research and Investment Strategy Jason Thomas points out, this wasn't the only reason.

Thomas points to Fed research that shows bond buying, or quantitative easing, cut the 10-year term premium by a full percentage point in the decade after the banking crash.

But given a weighted average maturity on the debt of less than six years, this explains less than a third of the decline in overall Treasury borrowing costs.

The rest, he posits, was down to a huge shift in the cash flow position of U.S. companies that had traditionally borrowed heavily to buy equipment, build factories, networks and logistics and competed with government for investment funds.

"After 2009, something changed," Thomas wrote. "Economic activity shifted decisively towards software, digital services, and 'factory-less manufacturing' businesses that focused primarily on product design, software development, and branding."

BONDS AND RE-INDUSTRIALIZATION

The explosion in "intangibles" and asset-light operations with far less need for property, plants and equipment and global customers meant companies were generating five to eight times more cash than they reinvested. Rather than borrowing 15% of GDP from investors as they had done in the past, companies suddenly found themselves lending 22% of GDP in the form of cash hoards, share buybacks and special dividends.

For many, this transformed corporate balance sheet was a central reason the Fed's recent interest rate hikes did not tip the economy into recession.

Along with Fed support, it freed up significantly large amounts of private capital to fund government's expanding debt piles too.

"Of course, there's another way to describe this economic transformation: de-industrialization," Thomas added.

And that's the trend U.S. President Donald Trump's administration is committed to reversing.

Thomas goes on to argue that the boom in artificial intelligence spending is already cutting corporate cash flow surpluses by some 75% relative to the previous expansion.

What's more, Washington's push to cut trade deficits via tariffs that boost domestic manufacturing could see the U.S. corporate sector turn back to a net borrowing position once more in coming years - competing with Treasury for funds once again.

"Those who've warned repeatedly of impending fiscal doom have a bad track record," the Carlyle strategist concluded. "But the AI capex boom and potential for policy-induced re-industrialization make their case more plausible."

For edgy Treasuries navigating the risk of higher government deficits and debt and structurally higher inflation and Fed interest rates over time, such a seismic shift in corporate borrowing trends could be another hammer blow.

The opinions expressed here are those of the author, a columnist for Reuters