This week’s spike in U.S. Treasury yields highlights the reality of a strong economy, stubborn inflation and rising debt costs.
This will put pressure on the debt-laden Trump administration as it tries to find a path forward for the economy.
It also highlights tensions between the country’s top two economic policymakers. Federal Reserve Chairman Kevin Warsh wants to hear from the market. Treasury Secretary Scott Bessent wants to use tools to change messages if they appear to be incorrect.
Bond yields soared on Wednesday and were trading near multi-decade highs on Thursday as traders digested a surprisingly strong Purchasing Managers Index after the Federal Reserve began raising short-term policy rates last week. of 2 years treasury The yield rose 10 basis points to 4.87%. 10 year treasury It rose 17 basis points to 5.12% on Thursday morning.
These yields are impressive by recent standards, but not so much over the long term. From 1990 to 2006, the average interest rate on a 10-year Treasury was about 5.9%, followed by several years of slow growth and generally low interest rates that reset Americans’ expectations about borrowing costs.
The economy looks strong right now, thanks in part to a surge in investment in artificial intelligence. Competition for capital is contributing to rising interest rates.
The boom is likely to deepen further. The Census Bureau reported last week that real median household income rose 2.6% to $87,460 and the poverty rate fell 0.5 percentage point to 10.2%.
The recent economic boom has been driven in part by massive tax cuts under the first and second Trump administrations, and by a surge in government deficit spending that is compounded by Iran war spending. This year’s federal deficit is expected to exceed 6% of gross domestic product, according to Congressional Budget Office data. The agency projects that the Tax Policy Act passed last year will increase the budget deficit by $4.7 trillion over 10 years, although tariffs will offset some of it.
This country is full of trust. Warsh, along with other Fed policymakers, cited large debt issuances by banks and other financial institutions and tight credit spreads (suggesting that borrowers are having little difficulty seeking loans) as key factors in voting in favor of raising rates.
In the days since then, several other Fed officials, including Governor Michael Barr on Wednesday, have said they believe further rate hikes will likely be necessary.
Bond yields likely benefited from Mr. Warsh’s decision to raise interest rates this week. If Mr. Warsh hadn’t addressed inflation, traders would have sent long-term yields soaring given the uncertainty of when and how the Fed would act.
But Mr. Warsh’s influence over this decade will likely be limited. “Our business is to ensure continued, sustainable and durable economic growth,” he said last week. Mr. Warsh and the Fed will try to contain inflation risks, but they don’t want to trigger a recession.
The Fed’s decision to raise interest rates highlights the potential for heightened tensions with the Treasury Department.
Mr. Warsh treats the 10-year Treasury as an important source of economic information. He called it “the most important asset in the world” at a recent press conference. He changed the way the Fed communicates, making it easier to read unfiltered market signals.
Meanwhile, Bessent has indicated he is willing to intervene if he believes the market is moving away from equilibrium. He recently stepped up the Treasury Department’s efforts to buy back some maturities of long-term government bonds in recognition of the “heat” in the market.
“I don’t believe you can change the equilibrium price, but nothing is in equilibrium,” Bessent said at a Breitbart event on September 8. “When there is an imbalance, my job is to try to move things back towards equilibrium.”
The stakes are high as the Treasury has to refinance huge debts while continuing to refinance huge deficits. Some markets expect the Treasury to reduce the supply of long-term bonds it issues in exchange for more short-term securities.
If the Fed raises short-term interest rates, that could be costly for the U.S. government and taxpayers.
Higher long-term interest rates increase risk. The Committee for a Responsible Federal Budget calculates that 5% of the 10-year Treasury bond is about 80 basis points above the CBO threshold. If things continue as they are over the next decade, interest costs will rise to $2.7 trillion a year, more than Social Security and Medicare, the bipartisan group said.
Rising average interest rates also mean that U.S. growth must remain high for a longer period of time for the country to have a chance of getting out of debt.
That already looks unlikely. The International Monetary Fund estimated earlier this year that the US government would need to run a primary balance surplus of 1% of GDP to put the US debt on a downward trajectory.
A shift toward fiscal consolidation is unlikely, as President Donald Trump has promised to provide $5,000 checks if Republicans win a landslide victory in the midterm elections.
The bond market doesn’t care about politics. The verdict is being passed on the cost of capital in a booming economy where inflationary pressures persist and massive government borrowing is required.
Policymakers may not like the decision, but they cannot ignore it.
