Bond Market Shudders as Tax Bill Deepens Deficit Worries

New York Times

22-05-2025

The bedrock of the global financial system continued to shudder on Thursday, as President 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 U.S. government 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, and the higher the yields, the more risk investors perceive in to lending to the government.
The 30-year Treasury yield on Wednesday rose as high as 5.15 percent 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.
Christopher J. Waller, an influential governor at the Federal Reserve, said on Thursday that financial markets are looking for more 'fiscal discipline' from Washington, warning that investors will likely continue to demand higher yields in order to hold U.S. 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.'
Mr. Waller said that investors more broadly were shunning U.S. assets and in turn demanding a 'premium' to buy. That so far has come in the form of yields on government bonds rising, indicating a drop in price.
'There does seem to be a risk-off on American assets across the board, not just government debt, but everything,' said Mr. Waller.
That aversion was last on full display when Mr. 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 U.S. stocks sold off, so too 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,' Mr. 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 percent 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 to the economy.
Ajay Rajadhyaksha, global chairman 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 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 from 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.
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 dramatically, something Beth Hammack, president of the Cleveland Fed, made clear earlier 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.'