US Government Bond Market Faces New Volatility
Investors might have thought the rough patch for financial markets was settling down, but fresh volatility in US borrowing costs suggests otherwise. Interest rates on long-term US government debt spiked above 5% this past Monday, a level not seen since October 2023, before pulling back slightly.
This surge followed a downgrade of the US government’s credit rating by Moody’s the previous Friday, a decision rooted in the rising debt observed over the last decade. In addition, Congress is pushing ahead with a tax and spending bill projected to add trillions to the already substantial $3.6 trillion debt.
Understanding Government Bonds
The government typically raises money by selling bonds—sometimes referred to as treasury securities—to investors in the financial market. In essence, investors purchase these bonds, lending cash to the government, which in turn promises to return it while paying interest over a multi-year period.
Much like conventional loans, bonds seen as risky tend to offer higher interest rates or yields. The buyer pool primarily consists of financial institutions, from pension funds to central banks. While some investors hold onto bonds until they mature, others may trade them with different investors.
Current State of US Bonds
Traditionally, the US government has managed to avoid high interest rates, primarily because the Treasury is viewed as a secure investment. The US economy’s resilience, combined with a reputation for reliability, has kept investor confidence intact.
After the financial crisis of 2008, Treasury yields remained around 3% for much of the decade. However, when yields hit 5% in October 2023, it marked the first instance in 16 years of crossing that threshold. Yields, as of this week, were measured at 5.04% before later stabilizing around 5%, jumping from 4.9% prior to the downgrade.
But what are the new concerns? Rising yields were first noted in 2021, linked to inflation spikes that emerged following the Covid-19 pandemic. Last month, renewed fears arose when former President Donald Trump enacted tariffs globally, raising issues about potential economic slowdown and price increases. Meanwhile, government debt continues to climb without clear solutions in sight.
On Friday, Moody’s downgraded the US credit rating, highlighting growing debt and the slow pace of resolving such issues. This move, while not shocking, came after Moody’s previously warned that action might happen in 2023. The urgency of this situation became clear as Congress voted over the weekend to proceed with a tax bill that could increase US debt by at least $3 trillion over the next ten years.
According to Macquarie Bank analyst Thierry Withman, “Moody’s downgrade is as much a political judgment as it is economic.” He added that the essence of these downgrades touches more on political and institutional challenges than merely the sheer volume of debt.
Impact on Everyday Americans
According to Moody’s projections, by 2035, it’s estimated that interest payments on US debt could consume around 30% of federal revenues, a stark increase from the 9% seen in 2021. Should the government allocate more funds towards servicing this debt, it could have serious implications for public budgets and spending.
Additionally, government interest rates typically influence the rates charged on various loans, such as mortgages and credit cards. Thus, when government rates go up, households and businesses may see their borrowing costs rise as well.
While many homeowners have fixed-rate mortgages ranging from 15 to 30 years, small businesses may struggle with the rapid changes in borrowing costs. Without access to credit, these businesses could stifle economic growth, potentially leading to job losses over time.
First-time homebuyers or those looking to sell and purchase new homes might also face steeper expenses in this environment.
