Treasury bond yields are at their highest in almost two decades.Kylie Cooper/Reuters
Kevin Yin is a contributing columnist for The Globe and Mail and an economics doctoral student at the University of California, Berkeley.
The Trump administration’s borrowing has finally begun to spook capital markets. On May 20, the 30-year U.S. Treasury bond yield closed at over 5 per cent for the first time in almost two decades, two days before the House of Representatives passed U.S. President Donald Trump’s “One Big Beautiful Bill.” Moody’s recently downgraded the U.S. credit rating, marking the first time that all three rating agencies have had the U.S. below their top rating. JP Morgan chief executive officer Jamie Dimon has predicted an eventual “crack” in the bond market.
There are a number of reasons for this, chief among them being the sheer magnitude of fiscal irresponsibility in the United States.
To be sure, none of this should be read as an indication that the U.S. is close to defaulting on its debt – something that would be historically unprecedented and utterly disastrous. While the elevated yields reflect to some extent the market’s suspicion that the risk has increased, it would be a misunderstanding of how the Treasury market operates to think that default is now on the table.
For one, 30-year yields have been here before, as recently as the late 2000s. Yields of 5 per cent are notable because they are part of a concerning trend, not because they are too high for the government to pay. And during the last Treasury auction, buyers were willing to purchase 2.46 times the amount of debt on sale, which was actually weaker than usual. Moreover, defaulting would almost certainly trigger a historic financial crisis, something Mr. Trump may not entirely understand, but his Treasury Secretary certainly does.
Opinion: Here’s what really is going on in the bond market - and why I’m still very bullish
But the much more immediate issue is that the global economy will suffer slowed growth from these higher costs of capital.
Why is this the case? At a high level, all money borrowed is money saved by someone else. The government is only one of many groups vying for those limited funds. Companies and individuals also compete for those very same resources, to invest in projects, pay employees and purchase homes via mortgages. If the government suddenly requires vastly more funds, there is much more demand and thus the price of that capital – that is interest rates – must rise. Thus government deficits can make borrowing more costly for everyone else, in a process known as “crowding out.”
To what extent can the current rise in yields be attributed to these rising deficits? Apparently a good deal. JP Morgan analysts argue that compensation for higher inflation expectations only explains a small portion of the increase. On the other hand, the non-partisan Congressional Budget Office estimates that for every 1-per-cent increase in projected debt-to-GDP, long-run interest rates tend to rise by two basis points. (A basis point is one-100th of a percentage point.) Academic studies have found larger effects, particularly from deficit increases. Debt-to-GDP is expected to grow by nearly 20 percentage points by 2035, corresponding to about half a percentage point in higher yields by the lower estimates.
Crowding out is not the only consideration for running deficits but given the size and dubious stimulus value of the current U.S. expansion, it is quickly becoming the most important.
Of course, there is more than one interest rate in the economy, but they are all linked. Rising yields in the long-term Treasury market can trickle into shorter-term maturities as well as consumer and corporate debt markets, as borrowers in these markets are forced to raise their own yields to compete for investor money. Ten-year Treasury yields, for example, are higher than they’ve been since the early 2000s, hovering just below 4.5 per cent. Triple-A corporate bond yields are now higher than they’ve been for a decade. All of this means that credit cards, mortgages and corporate borrowing are becoming more costly. All of this slows economic growth.
Bond markets are not stupid – these higher yields reflect real and worrying developments in fiscal fundamentals. The United States is now on track to owe more as a percentage of GDP than it has since the Second World War. This cannot continue indefinitely; at some point the government will realize that taxation or austerity measures will be necessary to correct the path. But the likely outcome for now is a rising cost of servicing the debt, slower growth from higher rates and a much greater burden on future generations.