NEW YORK (AP) – A tranquil spot on Wall Street is buzzing once more.
The bond market, typically perceived as sluggish, can deliver significant impact. Currently, there’s growing concern that Washington is gearing up to escalate its debt due to its tax-cutting ambitions.
The House has passed the Tax Securities, adding trillions to the federal debt before heading to the Senate. Rising U.S. debt worries are pushing yields higher in the bond market, shaking the stock market. The S&P 500 is on track for its worst week in seven years.
Historically, aggressive reactions from the bond market have compelled government policy adjustments, occasionally resulting in the ousting of political leaders. While many seasoned investors argue it’s premature to label the “bond market vigilantes” as active this time, the impact of rising yields remains significant.
“I don’t view this as apocalyptic, but it has tangible effects,” states Nate Thoof, senior portfolio manager at Manulife Investment Management. “Consider the mortgage rates.”
Let’s delve into what’s unfolding:
How is the bond market reacting?
The 10-year Treasury yield, a focal point of the U.S. bond market, has surged to 4.54% from last week’s 4.43%, up from just 4.01% at the start of last month. This represents a significant shift in a market where changes are typically measured in 1/100th of a percentage point.
This yield indicates the interest the U.S. government is willing to pay investors for lending money for a decade. Washington requires that capital due to its ongoing spending exceeding tax revenue. If bond investors hesitate to lend to the U.S. government, yields will continue to climb.
This increase is the sharpest for long-term bonds in a decade. Treasury yields previously surpassed 5% in 2010, approaching levels seen just before the 2008 financial crisis.
Why is the bond market distressed?
Bond investors detest inflation as it diminishes the purchasing power of future bond payments.
My concerns about rising inflation are multifaceted. Initially, there are President Donald Trump’s tariffs, which could inflate prices across various goods. More critically, the growing debt levels of the U.S. government pose a longer-term threat.
Doubts regarding U.S. debt intensified at the end of last week, when Moody’s downgraded the government’s creditworthiness, making it the last of the three major rating agencies to do so. This anxiety heightened as the House moved forward with the tax cut bill approved earlier on Thursday.
Other influences contributing to rising yields recently include increased optimism that the U.S. economy will avoid recession, especially in light of China’s easing of tariffs.
What about vigilantes?
Historically, the bond market has been influenced by policy decisions that elicited strong reactions. Occasionally, the response has been powerful enough to intimidate politicians.
Trump himself noted that the bond market may have influenced his earlier decision, commenting that investors seemed to be “a bit uneasy.”
This was reminiscent of the turmoil in the bond market when Liz Truss, the UK’s shortest-serving prime minister in 2022, faced pushback for her tax reduction and spending increase plans without a funding strategy. James Kerrville, an advisor to former President Bill Clinton, highlights the potential of a bond market uprising due to its significant clout.
Is the vigilante factor present now?
While there is a vigilance aspect in keeping Treasury yields in check, past bond market reactions may not suffice to deter Trump and Congress from their tax reduction agenda.
“I don’t anticipate this escalating into a crisis,” states Brian Leiling, head of global bond strategy at Wells Fargo Investment Institute. “I don’t foresee it reaching apocalyptic levels.”
As an example, Treasury yields stabilized on Thursday, and the rise in bond yields isn’t unique to the U.S.; similar trends are occurring in other developed nations, especially Japan.
Additionally, all known issues surrounding U.S. government debt have been flagged for years, with critics warning of an unsustainable trajectory. It may take years before the escalating debt burden triggers a panic in financial markets, according to Rehling.
So why should this matter?
Increases in Treasury yields mean taxpayer money will be utilized primarily to service national debt, rather than to support government operations.
Furthermore, higher yields can ripple through the economy, making loan access more challenging for U.S. households and businesses. For instance, mortgage rates tend to align closely with 10-year Treasury yields, with the average rate for a 30-year mortgage recently reaching its highest point since mid-February.
As Treasury yields rise, so do costs for everything from credit cards to auto loans. A significant increase in these costs could discourage borrowing and spending, heightening the risk of recession and potentially slowing the U.S. economy.
In addition, elevated yields may dissuade investors from purchasing stocks and other investments at high prices.
Of course, predicting these dynamics remains complex. “I don’t know how things will play out,” Leiling adds.
Source: apnews.com