With no appetite or plan for real deficit reduction, the government needs to count on people still being willing to buy Treasury bonds at favorable rates.
The odd behavior of Treasury yields also caught Greg Ip’s eye in the Wall Street Journal. The stock market decline was bad, but the signals from the bond market and the dollar are potentially much more troubling.
“Normally when investors are this scared they seek safety, and nothing is safer than the dollar and Treasury debt,” Ip writes. “But despite mounting fear of recession, the usual flight to safety hasn’t materialized.”
Investors had been attracted U.S. economic outperformance. Despite our complaints about slow growth, and despite the very real impediments to that growth that ought to be removed, the U.S. economy has been growing much faster than any other highly developed economy for years now. Supposed challengers such as Canada and Germany have fizzled out, and the U.S. has been pulling away from the field.
“The U.S. is still exceptional, but it is also less predictable, more antagonistic, and more isolated,” Ip writes. “For foreign investors, that makes it less safe.”
Both the dollar and the price of Treasury bonds fell while the stock market fell. “In the seven prior episodes when the S&P 500 fell as much or more [as it has since April 2], the dollar rose,” Ip writes.
Where are investors fleeing instead? Ip suggests that gold may be the new safe-haven asset instead of Treasury bonds. Reduced demand for Treasury bonds will keep upward pressure on yields, making government borrowing more expensive.
Net interest costs are already the third largest category of federal spending, after entitlements and defense. It is expected to surpass defense soon. The Congressional Budget Office assumes generally low interest rates for government borrowing when it makes its long-term projections. Here’s what the picture looks like if rates rise even a little bit, from my magazine piece on mandatory spending dominance from last year:
Interest payments are the really spooky part of the equation. According to estimates from Brian Riedl of the Manhattan Institute, if interest rates stay around 4 percent — the rosy scenario that the CBO uses for its baseline forecasts — 48 percent of federal revenue will go just to cover interest payments in 30 years. If rates gradually increase to 5 percent, that shoots up to 73 percent. If they increase to 6 percent, that’s all of federal revenue, just for interest payments.
With no appetite or plan for real deficit reduction, the government needs to be able to count on people still being willing to buy Treasury bonds at favorable rates. If that goes away over these tariffs, things will get much uglier much more quickly than they are already expected to be for the federal budget.