Why Washington's Huge Tax Bill Is Worrying Bond Investors

Miami Herald

21-05-2025

EDITORS NOTE: EDS: UPDATES graf "Since dropping ..."; EXPANDS graf "Now the concern ..."; REVISES next graf; TWEAKS graf "Apparent progress ..."; ADDS 2 grafs starting "There were glimpses ..."; UPDATES list of related stories.); (ART ADV: With photo.); (With: CONGRESS-FISCAL, CLIMATE-LAW-INCENTIVES, GLOBAL-TAX-FIGHT) ; Ben Casselman and Tony Romm contributed reporting.
For decades, budget hawks warned that America's debt load was unsustainable and that runaway spending financed with borrowed money was eventually going to scare investors away from lending to the United States. Those fears are now taking hold more strongly in the bond market, and are at risk of spreading further.
Tax cuts pushed by the Trump administration are amplifying debt and deficit concerns among bond investors, a powerful group of market players who strongly influence how much it costs for the government to finance its budget. The buying and selling of government debt, known as Treasurys, also influences interest rates on a wide variety of debt extended to American households and businesses, including mortgages, credit cards and car loans.
Those investors were already on edge over President Donald Trump's whipsawing tariff policy. Then this week's attempt to push through sweeping tax cuts without significantly slashing spending -- in what the president has called a "big, beautiful bill" -- set off a fresh bout of bond market turmoil. Trump put more pressure on Republican lawmakers Tuesday, visiting Capitol Hill and warning that failing to advance the bill would lead to higher taxes.
Since dropping below 4% in early April, the 10-year Treasury yield has risen back above 4.5%, a large move reflecting deficit worries. The moves for the 30-year yield this year have also been stark: On Wednesday, it rose above 5% to its highest level since October 2023.
Speaking with reporters Tuesday, Raphael Bostic, president of the Federal Reserve Bank of Atlanta, warned that volatility in the Treasury market could add to already heightened uncertainty about the economic outlook.
That risks making people "even more cautious about how they engage," he said. "If that happens, then I'll have to assess the extent to which that should change my outlook on how the economy is going to perform."
'Amping Up the Volume'
Last month, the chaotic rollout of Trump's tariffs on major trading partners caused bonds, stocks and the dollar to simultaneously drop in value, a rare combination that challenged the traditional role of U.S. assets as a source of safety and stability.
The president backed down on his steepest tariffs after a particularly severe spike in Treasury yields, which was started by selling because of computer-driven trading strategies but fanned by concerns that foreign investors were shunning U.S. bonds.
That retreat calmed markets somewhat, but the early signs of nervousness in the bond market are back.
Now the concern is that the administration's tax bill will add to the federal deficit, which is the difference between the government's income and expenditures. The Congressional Budget Office estimated Wednesday that the bill, as written at the start of this week, would add more than $3 trillion to the deficit.
That would mean more borrowing -- the U.S. federal debt is on pace to set a record, relative to the size of the economy -- and investors potentially demanding higher interest rates in return. Already there are signs that the premium demanded by investors to lend to the government has risen, a sign that they perceive a higher risk. In the language of the bond market, Treasurys could face even higher yields as their prices fall.
"We had an unsustainable budget path, and we're amping up the volume," said Lou Crandall, chief economist at Wrightson ICAP, a research firm. He spoke on the sidelines of the Atlanta Fed's annual conference, which was held this week in Fernandina Beach, Florida, and focused on financial stability.
Apparent progress in congressional negotiations over spending cuts seems to have tempered investors' worst worries for now, but yields remain close to where they were just before Trump was compelled to pause many of his tariffs.
Best Buy in the World?
Could the bond market sway Washington decision-makers again?
"We think it will take a much larger spike in order to impose any semblance of discipline on their process," analysts at Evercore ISI wrote in a note about the wrangling over the tax bill in Congress.
The yields spiked most recently after Moody's followed the other leading credit agencies and downgraded the United States' top-tier rating Friday. Trump's top economic advisers immediately condemned the decision, seeking to pin the blame on the Biden administration and offering a full-throated endorsement of U.S. assets.
U.S. bonds "are the best buy in the world," Kevin Hassett, the director of the National Economic Council, told reporters at the White House on Monday. He added that they would become an "even better buy once all of our policies are in place."
But some investors are skeptical, especially if the Republican-controlled Congress does not make substantive changes to the current bill. The final terms are still being negotiated, after backlash from Republicans who have sought more measures to curtail spending, some citing the Moody's downgrade to support their position.
"I don't think we have seen the end of the negotiations," said Mike Goosay, chief investment officer of fixed income at Principal Asset Management. It would be a "net negative to increase the debt burden by another $3 or $4 trillion," he said of the current proposal.
Much of the government's current debt was built up by both parties when interest rates were much lower. Now, rolling over that debt with new bonds is much more expensive, accounting for more than $1 trillion of government spending this year, roughly twice what it was five years ago.
It costs the government more to pay interest than it does to fund national defense or to pay for Medicare and Medicaid. The interest bill is second only to Social Security outlays.
And if investors start to back away from the Treasury market more aggressively, it could start to cause ructions across markets.
Nathaniel Wuerffel, head of market structure at BNY Mellon, said in an interview at the Atlanta Fed conference that a large Treasury market could be sustained if the economy was growing robustly and buyers and sellers could easily transact with one another.
If those conditions weaken, and if "debt servicing costs accelerate, then it could create some problems," warned Wuerffel, who previously worked at the Federal Reserve Bank of New York.
There were glimpses of what could happen when, on Wednesday, an auction of new 20-year Treasury bonds received tepid demand from investors, amplifying a sell-off in the bond market.
The auction also catalyzed a sell-off in the stock market, helping drag the S&P 500 more than 1% lower for the day, its sharpest drop in a month.
Bracing for a Tipping Point
Lower immigration and higher tariffs, which threaten to stoke higher inflation, have already prompted the Fed to put interest rate cuts on hold for the foreseeable future as it assesses the impact of the administration's policies.
And if tariffs significantly curtail U.S. imports, foreigners will have fewer dollars to reinvest in the Treasury market, potentially sapping a crucial source of government financing as the current administration continues to issue new debt.
The Fed's short-term rates have an influence over longer-term Treasury yields, so if the central bank keeps its rates higher for longer, the cost to the government is likely to grow over time.
"We are going to see our interest expense drift higher," said Peter Tchir, head of macro strategy at Academy Securities, an investment firm. "For now it is just a slow bleed, but at some point we are going to have to address all of this mandatory spending."
Investors are trying to figure out the "tipping point" at which the level of government debt spooks traders enough to spur serious market turmoil, said Crandall of Wrightson ICAP. "The level of debt is economically painful, but it's not crushing us yet," he said.
John Williams, president of the New York Fed, acknowledged that there had been increased discussion of whether investors still wanted to be as heavily invested in U.S. government debt and related assets. So far, those concerns have been mostly "people talking about talking about things" rather than an actual shift in investor behavior, he said at a conference in New York on Monday.
Investors are "obviously thinking about the volatility in these markets," he said. But, he added, the U.S. economy is still "an incredibly dynamic high-growth economy and, relative to our peers, one that is very safe and sound."
That said, even a modest pullback by investors could pressure U.S. markets.
Tchir expects gradually falling demand at the debt auctions that the Treasury Department runs and, over time, "higher highs" in yields whenever there is a spike, he said.
"If you want to reduce your exposure to the U.S., Treasurys are the easiest way to do that," he said.
This article originally appeared in The New York Times.
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