Fiscal concerns and doubts on Fed independence send US yields to long-term highs
- US 30-year yields hit fresh 19-year highs above 5.3% on Friday.
- Concerns about the US ballooning debt and the lack of clear guidance from the Fed have set US Government bonds under pressure.
- Treasury yields are rising globally with central banks running out of options.
US Treasury yields keep rising across the curve this week, with the yield for the 30-year Treasury bond reaching its highest level since 2007, during the global financial crisis, at 5.33% so far on Monday. A mix of concerns about the ballooning US fiscal deficit and growing doubts about the Federal Reserve’s (Fed) Independence are increasing pressure on US Government Bonds.
Shorter-term Treasury yields are also on the rise. The benchmark US 10-year yield is trading at one-year highs above 4.7%, and the 2-year yield hit six-month highs above 4.3% on Monday before easing to the 4.2% area on Tuesday.
US fiscal deficit keeps growing
Investors are requesting higher compensation to borrow US Government debt, as the fiscal deficit continues growing without a clear plan to reverse the situation on sight. Data released by the US Treasury revealed that the budget deficit rose to $432 billion in July, 48% above July last year and the largest gap since the $660 billion in March 2021, which reflected a sharp increase in spending due to the COVID-19 relief program.
Fed uncertainty is pushing yields higher
Beyond that, the latest Fed monetary policy meeting triggered serious doubts about the central bank’s commitment to combat above-target inflation. Markets are increasingly wary that Governor Kevin Warsh will bow to US President Trump’s pressures to avoid tightening borrowing costs, which has put the bank’s independence into question, adding pressure on Government Bonds.
DBS Group Research warns that “rather than reinforcing the USD’s haven credentials, the gathering could expose the policy uncertainty facing US bondholders due to limited forward rate guidance amid heavy Treasury issuance,” underscoring how shifting expectations around US policy and funding may complicate the (USD) currency’s usual response to higher yields.
Central banks are running out of options
This trend, however, is not exclusive to the US. Analysts at Rabobank observe a generalised surge in long-term yields as "most economies are already carrying far too high a level of public debt.” US 30-year bond yields are now “5.31%, the highest since July 2007”; UK 30-year Gilt yields stand at “5.84%, the highest since May 1998”; German 30-year Bunds are “3.74%, the highest since August 2007”; and Japanese 30-year JGBs are at “4.12%, the highest since that maturity was introduced in 1999, and vs. around 0.65% during Covid.” according to Rabobank experts.
Rabobank contrasts this backdrop with what it calls “the old world order,” where it was largely “a matter of time until central banks stepped in to calm things. The bank questions “how can they do so” in the current environment: "with rate cuts that steepen the curve more and an EM-style shift to bills from bonds? Or with rate hikes in an economy that needs to spend much more? Or with yield curve control? Or with rhetoric? Or with prayer?”
Central banks FAQs
Central Banks have a key mandate which is making sure that there is price stability in a country or region. Economies are constantly facing inflation or deflation when prices for certain goods and services are fluctuating. Constant rising prices for the same goods means inflation, constant lowered prices for the same goods means deflation. It is the task of the central bank to keep the demand in line by tweaking its policy rate. For the biggest central banks like the US Federal Reserve (Fed), the European Central Bank (ECB) or the Bank of England (BoE), the mandate is to keep inflation close to 2%.
A central bank has one important tool at its disposal to get inflation higher or lower, and that is by tweaking its benchmark policy rate, commonly known as interest rate. On pre-communicated moments, the central bank will issue a statement with its policy rate and provide additional reasoning on why it is either remaining or changing (cutting or hiking) it. Local banks will adjust their savings and lending rates accordingly, which in turn will make it either harder or easier for people to earn on their savings or for companies to take out loans and make investments in their businesses. When the central bank hikes interest rates substantially, this is called monetary tightening. When it is cutting its benchmark rate, it is called monetary easing.
A central bank is often politically independent. Members of the central bank policy board are passing through a series of panels and hearings before being appointed to a policy board seat. Each member in that board often has a certain conviction on how the central bank should control inflation and the subsequent monetary policy. Members that want a very loose monetary policy, with low rates and cheap lending, to boost the economy substantially while being content to see inflation slightly above 2%, are called ‘doves’. Members that rather want to see higher rates to reward savings and want to keep a lit on inflation at all time are called ‘hawks’ and will not rest until inflation is at or just below 2%.
Normally, there is a chairman or president who leads each meeting, needs to create a consensus between the hawks or doves and has his or her final say when it would come down to a vote split to avoid a 50-50 tie on whether the current policy should be adjusted. The chairman will deliver speeches which often can be followed live, where the current monetary stance and outlook is being communicated. A central bank will try to push forward its monetary policy without triggering violent swings in rates, equities, or its currency. All members of the central bank will channel their stance toward the markets in advance of a policy meeting event. A few days before a policy meeting takes place until the new policy has been communicated, members are forbidden to talk publicly. This is called the blackout period.
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