Bond market shudders as tax bill deepens deficit worries

Observer

23-05-2025

Colby Smith and Joe Rennison
The market for US government bonds, the bedrock of the global financial system, continued to shudder on Thursday, as President Donald Trump's bill to extend expensive tax cuts and create new ones without significantly slashing spending passed through the House of Representatives. The bill has unnerved investors, deepening worries that the country's debt is becoming unmanageable.
Yields on US bonds, which underpin consumer and business interest rates around the world, from mortgages to corporate loans, have been rising in recent weeks. Yields rise as prices fall. Higher yields reflect investors' concerns that lending to the government by buying its debt has become more risky.
The 30-year Treasury yield rose as high as 5.15 per cent in early trading, its highest since October 2023, before easing back later in the morning. The 30-year yield is trading about 0.7 percentage points higher than its low in April — a huge move in such a short time in that market.
The lectern is prepared for a news conference at the Capitol in Washington on Thursday morning, May 22, 2025, after the House narrowly passed a wide-ranging bill to deliver President Donald Trumps domestic agenda. (Kenny Holston/The New York Times)
Christopher J Waller, an influential governor at the Federal Reserve, said on Thursday that financial markets were looking for more 'fiscal discipline' from Washington, warning that investors are likely to continue to demand higher yields in order to hold US assets.
'We ran $2 trillion deficits the last few years — this is just not sustainable and so the markets are looking for a little more fiscal discipline,' he said in an interview with Fox Business. 'They're concerned.' Waller said that investors more broadly were shunning US assets and in turn demanding a 'premium' to buy. That so far has come in the form of rising yields on government bonds, indicating a drop in price.
The Trump administration has denied that the latest bill will be detrimental to the country's financial standing, despite the United States' loss of its top-tier credit rating status last week.
Russell Vought, who leads the Office of Management and Budget, said the decision by Moody's, which downgraded the nation's debt on Friday, was misguided and an attempt to 'sink the president's tax cut.' 'The notion that this was in any way harmful to debt and deficits is fundamentally untrue,' he said.
But others on Capitol Hill disagree, citing the recent turbulence in the bond markets.
Rep Chip Roy, R-Texas, acknowledged the 'issues in recent days' — after the downgrade — as a sign that the nation 'needs to have fiscal discipline.' Appearing on CNBC, he said the bond markets had actually been 'a little helpful,' as he and his fellow conservatives tried to push for even deeper spending cuts. 'And this bill, by the way, I've got to be honest, we took a step, but, man, we've got a long ways to go,' he added.
The rising cost of borrowing has prompted American businesses to flock to European debt markets to raise new cash, taking advantage of the relatively lower interest rates on offer, according to a research report from Bank of America.
'There does seem to be a risk-off on American assets across the board, not just government debt, but everything,' Waller said.
That aversion was last on full display when Trump announced his most aggressive set of tariffs in early April, which he was forced to walk back days later after traditional relationships in financial markets started to break down. As US stocks sold off, so did the dollar and government bonds, which typically act as safe havens.
'As long as the economy gets back on a good path — the economy starts growing, inflation stays down — you might see a resurge in demand for American assets,' Waller said.
He reiterated that there was still a path for the Fed to lower interest rates this year, barring the return of significantly more onerous tariffs.
'If we can get the tariffs down closer to 10 per cent and then that's all sealed, done and delivered somewhere by July, then we're in good shape for the second half of the year,' he said of rate cuts.
Investors warn that the fiscal package that eventually passes may end up keeping the Fed on hold for even longer because the measures will at least in the near term support the economy.
Ajay Rajadhyaksha, global chair of research at Barclays, is still maintaining his call that the Fed will cut once in December, but said it was increasingly plausible that the central bank would opt to do nothing all year.
Deficit hawks have warned for a long time about the risks of running large deficits, where the government spends more than it earns in taxes and other revenue. Those fears intensified after interest rates rose rapidly in 2022, making cheap debt taken on when interest rates were low suddenly a lot more expensive to maintain long-term.
This year, the government will spend more than $1 trillion on interest payments on its debt, more than military spending and twice the government's interest cost five years ago.
Investors had hoped that a Republican sweep of Congress, backed by a president who made cutting government spending a core message of his campaign, would provide the opportunity to meaningfully tackle the federal deficit.
Given that backdrop, Thursday's passage of a bill that would extend tax cuts, introduce some new ones and add more than $3 trillion to the deficit — based on figures from the Congressional Budget Office — weighed on the market.
The S&P 500 was roughly flat in early trading. The dollar rose against other major currencies, only partly reversing a three-day slide.
Despite the uneasy mood across Wall Street, financial markets are still functioning smoothly.
Officials at the central bank are unlikely to intervene unless that changes drastically, something Beth Hammack, president of the Cleveland Fed, made clear this week at the Atlanta Fed's conference on financial stability. She described the bar for the Fed to step in as 'incredibly high.' 'It needs to be a level of dysfunction where participants are unable to conduct business, banks are unable to lend credit,' she said in a moderated discussion. 'When we need to help support the financial markets is when there can be meaningful transmission into that real economy.' — The New York Times