Donald Trump’s proposed “One Big Beautiful Bill Act” would do it with very big tax cuts. This move has raised concern from bond market investors. Analysts predict that this record setting tax legislation may increase the United States national debt by anywhere from $3 trillion to $5 trillion. They are hoping to see that increase over the next 10 years. Because of this, doubts as to the value and stability of U.S. government debt are gaining in popularity.
The implications of this proposal are vast. Because so long as investors want more for U.S. bonds, they will demand higher returns and in doing so, fundamentally transform the global financial landscape. In recent weeks, the yield on the 10-year U.S. Treasury has continued rising, hovering between 4.1% and 4.5%. Until recently this increase represented a large shift from the much lower “risk-free” rate of roughly 4.25%, making it the most important global capital cost benchmark.
Rising Bond Yields and Economic Impact
The recent rise in U.S. bond yields would have an outsized impact on the cost of capital for American firms and families. If bonds are perceived as riskier, financial institutions and investors will want higher returns. This change will almost certainly raise interest rates on all types of loans and mortgages.
This would send a ripple effect through consumer spending given that 70 percent of the economy comes from consumer spending. In turn, consumers will eventually need to reduce their spending. Municipal analyst Andrew Lilley explained that we are seeing bonds and equities fall together in price. This reality is further squeezing funding sources, he noted. With high costs of borrowing on the rise, the overall environment for economic growth will be increasingly difficult.
Additionally, continued uncertainty about the global economic picture could make financial markets’ responses to U.S. government actions all the more unpredictable. Bond yields are beginning to spike, and this may soon cause a sovereign debt crisis of historic magnitude. If we are indeed in the midst of a government debt crisis, it’s something that’s been brewing for 25 years,” Lilley warns.
Concerns about U.S. Sovereign Debt Credibility
The credibility of U.S. sovereign debt is under increasing doubt as government borrowing has been on an unsustainable path for the last 30 years. This has put investors on watch, forcing them to re-evaluate their outlook on U.S. bonds. New Reserve Governor Michele Bullock stressed their watchfulness. She said, “We are certainly concerned about that, and we’re hired to be concerned about that kind of thing.”
If bond yields resume their march upward, the consequences may go deeper than increased borrowing costs. SNP James Wilson, pictured above recently at the ANU, said today, “Clearly the Reserve Bank is enormously concerned about the unfolding global growth story. Higher long-term funding costs will necessitate adjustments in monetary policy, potentially prompting the Reserve Bank to cut the cash rate if long-dated yields persist in their ascent.
The increased interconnectedness of U.S. Treasury yields with other financial instruments adds another layer of complexity to the picture. Wilson explained that the 10-year U.S. Treasury yield is critical for various sectors: “It gets used for corporate lending, it gets used for sovereign lending — so where the government can borrow money, and it gets used for mortgages.” As such, movements in Treasury yields have a profound impact on an array of financial transactions.
Potential for Recession
Economists fear that persistently high U.S. government bond yields could send the economy tumbling into recession again. If this trend is allowed to continue, it will even drive the entire country into recession. The ramifications of this could be massive, eroding support for similarly green domestic action and destabilizing international markets.
Investors are still trying to figure out how to navigate all these unknowns. Lilley pointed out that this scenario is what gets everyone’s juices flowing, forcing them to yell for increased government bond yields. This narrow focus spurs a self-reinforcing cycle. With every jump in yields, investors and consumers become more nervous.
