23-05-2025
Reserve Bank on high alert for economic fallout as Donald Trump continues to spook investors
US 10-year Treasury bonds have long been considered "risk-free" — until now.
That's put the usually circumspect Reserve Bank of Australia "on alert" for a potentially "cataclysmic" economic event.
Up until now, if you gave the US government money over a 10-year period, you were, essentially, certain to get your money back with interest, on average, 4.25 per cent.
That's known as the yield or interest rate.
The return on this debt security is so stable and secure, many other securities are priced off it, including US mortgage securities.
So, what happens if US bonds, or debt, become riskier, and investors demand a higher return?
The answer is that the global financial system fundamentally changes, and that affects every Australian.
The bond market is now regularly questioning the value and stability of US government debt.
That has not happened in the post-World War II era.
This week's Donald Trump's so-called Big Beautiful Bill is the latest catalyst to rile bond markets.
In the lead-up to the passage of the bill through the US House of Representatives, the US Treasury Department tried to secure $16 billion of funding through the sale of 20-year bonds.
It found the auction harder than usual to execute due to a lack of demand from investors.
Investors are wary because President Donald Trump's tax bill is projected to add $3 trillion to $5 trillion to the US debt over the next 10 years.
The passing of the bill through the US House of Representatives, by just one vote, saw bond yields soar on Thursday night (Australian time).
"Over the last few years … we've gone through one of the biggest inflation periods and rate hiking cycles in decades," Jamieson Coote Bonds senior portfolio manager James Wilson said.
"Since the 1990s, in all that time, if we think back, there's been a shocking narrative about higher yields.
"In reality, the 10-year US Treasury yield has] traded above 5 per cent only once and that was back in October 2023 and it lasted there for about 5 to 6 hours," he said.
The 10-year US Treasury yield is yet to trade above 5 per cent this year. It's currently above 4.5 per cent.
But when the passage of Trump's bill hit trading terminals across the globe, the 30-year Treasury bond yield touched a level not seen since 2007, of 5.13 per cent.
The catalyst for the latest round of selling was Moody's downgrade of US debt from Aaa to Aa1.
Moody's downgrade said, ever-so-subtly, US debt had become riskier for the lender.
It clearly has.
But how does it affect you?
The problem is that many assets and securities across the globe use US Treasury bonds as a reference rate.
Put simply, the more yields rise for US bonds, the higher the borrowing costs for US businesses and households.
This makes it increasingly difficult for big US corporations to raise funds and grow their profits and may lead to US consumers pulling back on their spending.
"So, if we think about the global cost of capital, the 10-year US Treasury is the benchmark," James Wilson said.
"It gets used for corporate lending, it gets used for sovereign lending — so where the government can borrow money, and it gets used for mortgages."
In short, if US government bond yields continue to rise, it risks pushing the US into recession.
This would affect both Chinese and Australian economic growth, and therefore employment.
This would be compounded if both bond and share markets fell together. Given that shares are valued, in part, against the "risk-free" return that can be obtained from US Treasuries, rising yields tend to put downward pressure on share prices because investors demand a higher return.
"So, especially when both bonds and equities are both falling in price, this is tightening funding conditions," Barrenjoey's interest rate strategist Andrew Lilley said.
"And also [it's going to cost more] if you then go to the debt market while you're paying more.
"That's the way in which this kind of reinforces itself."
He says, "at the margin", higher US bond yields "could push the Reserve Bank to cut the cash rate, if long-dated yields keep climbing."
This would be to support Australian businesses borrowing from the US, and the economy more broadly.
"Basically, the higher long-term funding costs are the lower the RBA needs to make [the cash rate].
"That's the simplest way of putting it."
The Reserve Bank is known for its understated commentary.
Not so this week.
It made it clear to everyone that the Monetary Policy Board's decision to cut the cash rate from 4.1 per cent to 3.85 per cent was due in some part to the small but rising risk of a "severe downside scenario".
Governor Michele Bullock was asked if that included a "cataclysmic" financial markets event, and a recession.
"Well, yes," she responded, "we are on the alert for that, and we're paid to worry about that sort of thing."
"And we have been watching that very closely as have other central banks all around the world.
"I'm not putting a strong possibility on a really, really bad outcome, but I think we have to be alert that there might be [one].
"[And] if you look at our scenario analysis, it does suggest that in a really bad outcome there could possibly be an [Australian] recession, yes, but that's in the very extreme," Governor Bullock said.
The Reserve Bank has already shifted its unemployment rate forecast up slightly to peak at 4.3 per cent. It's currently 4.1 per cent.
"Look, without a doubt that the Reserve Bank is quite worried about the global growth story," James Wilson said.
It all comes back to Trump, how his tariff policy will play out, the future credibility of US sovereign debt, and how financial markets ultimately respond to ongoing confusion about the global economic outlook.
"If we are in the middle of a government debt crisis, it's something that's been brewing for 25 years," Barrenjoey's Andrew Lilley said.
"And nothing in the last week has really accelerated that.
"But the attention [on ballooning US government debt] just becomes salient to everybody at the same time and everybody starts saying well these government bond yields need to be higher and it's not because of the news, but it's because of the new attention."
The suggestion is that US government borrowing has been on an unsustainable path now for decades.
Enter Donald Trump, and the true scale of the fiscal crisis is being realised.
