Why the bond market is barfing
Around the world, investors are sending a clear-as-glass signal: After years of profligate debt issuance, the world's major economies are now facing the bill.
The big picture: A sell-off in bond markets over recent weeks is signaling that the long-term trajectory for interest rates is higher than it has been in decades. The drop in long-term bond prices means a rise in the interest rates governments must pay to borrow money.
The anticipated multitrillion-dollar widening of U.S. deficits due to the tax cut and spending legislation that passed the House early Thursday morning is part of the story, as is the Moody's downgrade of the U.S. government's credit rating last week.
But it's really a bigger, global phenomenon — suggesting a step-shift in what savers demand to tie up their money in the long term across major advanced economies.
Driving the news: The 30-year U.S. Treasury bond yield touched 5.13% at one point Thursday morning, the highest since 2007. On Wednesday, an auction of 20-year bonds showed surprisingly soft demand.
In Japan, with the highest ratio on Earth of debt to the size of its economy, long-term bond yields have hit new all-time highs this week. The nation's 40-year bonds were yielding 3.69% Thursday, up more than a percentage point from early April.
Long-term rates in the U.K., Canada and Europe have similarly marched upward, if less dramatically.
State of play: Moves in shorter-term bonds have been more modest, meaning what has changed is not investors' near-term expectations for the economy, inflation, and monetary policy, but rather the riskiness of locking their money in at low rates.
In general, a steeper yield curve — higher long-term rates than short-term rates — implies a stronger growth outlook. But there are reasons to think something else is afoot.
In a volatile world economy — one in which globalization marches backward or other negative supply shocks arrive — central banks might need to crank rates higher in the coming decades to keep inflation from taking off.
Moreover, investors worry there will be more government debt issuance in the coming decades than savings to absorb that debt.
What they're saying: "This rise has taken place not for virtuous reasons around faster growth but rather because of risks around higher inflation and the need for higher interest rates to compensate for holding long-dated dollar-denominated assets," wrote Joe Brusuelas, chief economist at RSM, in a note.
"The risks and opportunities around holding such debt are part of the explanation," he added. "A structural change is taking place in the market, forcing a general repricing of risk."
The long-term bond sell-off has serious implications for both ordinary American borrowers and the nation's long-term fiscal picture.
Zoom out: Because rates on Treasury securities form the bedrock costs for all other forms of borrowing, these higher costs will eventually show up in the form of more expensive mortgages and car loans.
The good news is that those forms of lending are anchored to shorter-duration rates. Even if you take out a 30-year mortgage, for example, lenders know it will likely be paid off long before that as you move or refinance.
And shorter-duration rates aren't up much.
Yes, but: If bond investors are correct about the long-term trajectory of rates, there will be higher borrowing costs and more lending activity crowded out by the government in the years and decades ahead.
Zoom in: If the higher long-term rates hold, it implies meaningfully higher debt service costs for the U.S. government's existing debt pile. That could squeeze the government's ability to pay for other priorities, whether national defense or maintaining the social safety net.
The bottom line: "Everybody I have talked to in financial markets, they are staring at the [big, beautiful] bill and they thought it was going to be much more in terms of fiscal restraint," Federal Reserve governor Christopher Waller said Thursday morning on Fox Business.
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