US bond yields are soaring.
Bond yields in any country rise for one or more of the following factors:
- Inflation has risen and/or is expected to rise.
- Growth is picking up.
- The government deficit is ballooning
- Default risks are rising.
In the US, inflation is expected by the markets to remain high. This is because of the soaring oil price as a result of the Iran war, and also because the new Governor of the Fed Kevin Warsh is Trump's creature, and is suspected of being soft on inflation. It's also because of Trump's penchant for tariffs.
Growth appears to be picking up, for now, which makes it more likely the Fed Funds rate will be raised rather than lowered. This will push up long bond yields, unless the markets decide it will increase the risk of recession.
The federal deficit is exploding, thanks to Trump's tax cuts as well as the Iran war. Tariffs, on again then off again then back on again, have not plugged the gap. The big cuts DOGE was supposed to bring have turned out to be mouse-sized. The Trump administration is unlikely to take any action to reduce the deficit, and the Iran war is not going away.
Default risks are rising. The deficit has doubled from $20 trillion in 2017, to $40 trillion. Paying the interest charges is now the largest single item in the Federal budget. This makes it harder to repay the debt, because as interest rates rise, the debt and interest burdens increase. And Trump has repeatedly gone bankrupt in the past, and may think that a US debt default would be as painless as his property companies going to the wall. Then there was some half-wit in the administration (whose name escapes me) who proposed recalling the debt and issuing new paper for half the value of the old. Or maybe at half the yield. Either way, that is, of course, a default.
A further unique factor to this crisis is that foreign central Banks of countries which were once allies of the United States — Canada, Europe, Japan — are big holders of Treasuries, as is China, and could decide to sell for political reasons. They probably won't because they know the risks better than I do, but I would not be at all surprised if they were quietly allowing their Treasury holdings to run off and replacing them with gold, bought by intermediaries, and not held in the vaults of the New York Fed. Trust in the US has gone, and that makes everything much harder to navigate, and much riskier.
Bond yields are at 20-year highs, and are still rising. This creates a doom-loop, where interest rates rise, increasing the deficit as new paper is issued, which increases the interest burden which causes interest rates to rise even further. It was this dynamic which created the Euro crisis 15 years ago.
The US bond market is central to the operation of global financial markets. A default would cause a deep global depression. One hopes that the grown-ups will act in time to prevent this catastrophe. But will they?
