In the days before Memorial Day weekend, yields on 30-year Treasury bonds hit a 19-year high of 5.2%, while the 10-year benchmark hit 4.7%, the highest level since mid-2007. If such returns materialize, the federal interest expense scenario laid out in CBO’s “Budget and Economic Outlook: 2026 to 2036” report published in February gets out of a difficult situation with almost disaster. The takeaway: America’s path to financial security has lost all margin for error, and nothing illustrates this better than the long-term impact of higher-than-expected rates. America has so little room to maneuver that returns that even modestly exceed the CBO’s “baseline” pack a huge extra hit when the numbers combine in coming years, leaving out huge chunks of revenue that would otherwise go to funding basic needs like Defense, Social Security, and Medicare.
CBO estimates that yields on 30- and 10-year Treasury bonds will average around 4.65% and 4.15%, respectively, through Fiscal Year 2036. This equates to approximately 55 basis points lower It’s up from a multi-year peak briefly held in late May. Doesn’t seem like much of a difference, right? And unless the interest expense on our massive and ballooning $39 trillion national debt, which is already about $1 trillion a year, larger than Medicare spending and equal to two-thirds of Social Security spending, a half-point upward change would probably be manageable.
But a recent report from the nonpartisan Committee for a Responsible Federal Budget quantifies the profound damage that even continuing the recent summits would cause. By 2036, interest expenses will go from consuming 14% of all income to 30%; That’s five points higher than the CBO’s estimate. Carrying costs of $2.5 trillion, 2.5 times today’s figure, would become the second largest budget category, surpassing Medicare by a third. Interest costs per household will rise from $7,900 last year to $17,000 in ten years.
Much of today’s extreme vulnerability to slightly higher rates stems from the need to both refinance existing debt and shoulder trillions of new bonds at much higher cost to cover deficits. In total, the federal government will need to borrow approximately $10 trillion over the next 12 months, accounting for one-third of our total debt. This amount includes approximately $7.5 trillion to repay maturing Treasury securities and $2 trillion to close the gap between revenues and spending. The main reason the US accumulated so much debt in the first place was the lure of extremely bargain returns orchestrated by the Fed’s easy money policy during and after the COVID crisis. Treasury Bills maturing within one year from 2021 through early 2022 offered a very small offering of around 0.2%. Today, this cost is 18 times higher at 3.7%.
Rates also rose for 5- to 30-year Treasury Bills, which account for more than half of all federal debt outstanding. Since we can borrow very cheaply for a long time, the average interest rate on bonds is only 3.23%. But the U.S. is refinancing bonds that returned to a much higher value, 5.2% in the 30th year and 4.7% in the 10-year period just before Memorial Day.
In fact, the borrowing boom that has gotten the United States into so much trouble is reminiscent of the rush on “teaser” mortgages that preceded the housing meltdown of 2007; people were caught up in temporary, extremely low “publicity” rates; When these rates were reset higher, borrowers were saddled with monthly payments they could not afford. A similar dynamic is at work as the United States refinances low-yield treasury bonds issued at today’s much higher rates in what appears to be a deal to finance massive government spending.
As of May 26, news that the Iran War may soon end has pushed 30- and 10-year yields slightly lower, and they are now about 35 basis points above the CBO forecast. Still, the threat that they will return to the half-point-plus margin is so frightening, prompting a stern warning from new Fed chief Kevin Warsh. It’s encouraging that Warsh publicly supports tight monetary policy by reducing the massive amount of Treasuries on the Fed’s balance sheet; a policy that involves offloading a large portion of its portfolio to the public. This gamble saves trillions that would otherwise be spent.
Shrinking the Fed’s balance sheet would also shrink the very thing that’s causing the problem: overly high “aggregate demand” that sends too many dollars chasing a much slower-growing volume of goods across the economy. (Famous economist Will Luther I described this phenomenon in my last story.) Warsh could also raise the Fed Funds rate, or even announce that there are no plans to cut it, to cool the relatively abundant credit that is fueling big spending by consumers and, of course, massive spending on AI data centers. But the main reason why aggregate demand is so high is excessive levels of government spending, which, if left unchecked, could lead to rates higher than the peak figures that triggered such a shakeout. Warsh could help by increasing the cost of credit to cut both consumer and corporate spending and by selling the Fed’s holdings of bonds to target the latter. But he can’t control the biggest one: the out-of-control federal budget.
This responsibility falls to the President and Congress. As the CRFB notes in its analysis of the impact of rising yields, “The best way to achieve these goals is to reduce deficits, which can help the Federal Reserve lower rates by reducing short-term inflationary pressures, putting downward pressure on long-term interest rates by lowering economic interest rates.” crowd coming out [that diverts money needed for budget must-pays to interest]and reduce the debt burden on which the government must pay interest.” The CRFB adds that if yields remain in the pre-Memorial Day range or rise higher, they threaten to “cause a financial crisis.”
Nothing shows that AMERICA IS BROKEN better than the disastrous rise in yields that often seem inconsequential when our financial situation is this fragile. Neither party wants to talk about how broke we really are or do much to fix the problem. Unfortunately, it may take the emergence of unaffordable interest rates to force our legislators to confront the danger they have created.
This story first appeared on: Fortune.com
