Market Brief: Yields Push Higher as Debt Worries Intensify

Treasury markets are extending their losses this morning on worries that funding strains could reach unsustainable levels after the House of Representatives passed President Donald Trump's broad-reaching tax-cut bill. By a 215-to-214 margin, the lower chamber passed what Trump has called his “one, big, beautiful” bill early this morning, with two Republicans and all Democrats voting against it. The 30-year Treasury yield is closing on the 5.15-percent threshold, nearing levels only temporarily breached during the Fed-induced selloff in 2023, and previously touched in 2007. The dollar giving back some of its overnight gains, and most of its major counterparts are holding steady as traders await new catalysts.

In the short term, the legislation should have a stimulative effect on the US economy. The bill proposes to extend 2017’s tax cuts and add new ones, while boosting outlays on border security, national defence, and farm support programmes, even as it imposes smaller cuts to Medicaid and nutrition assistance. Updated projections are not yet available, but on net, our estimates* suggest that the “fiscal impulse” – the contribution of fiscal policy to gross domestic product growth – could turn modestly positive in the next fiscal year as less than $175 billion of spending cuts are offset by $750 billion in new borrowing. On the trajectory established under previous governments – both Republican and Democratic – and reinforced by this morning’s bill, the US is highly likely to continue running deficits that are typical of wartime conditions in the decade ahead, driving debt-to-gross domestic product ratios to unprecedented levels.

In a sense, this might partially offset weakness in the corporate sector as tariff increases hit profit margins. As a slew of earnings reports have recently shown, America’s largest companies are bracing for a downturn ahead as abysmal consumer confidence levels translate into weaker revenue growth, economic uncertainty impacts growth and investment plans, and tariffs at current levels take a serious toll on profit margins. More government spending and lower taxes might help alleviate the broader economic effects and keep profits aloft for now.

But investors are growing increasingly wary of funding a country that has seemingly abandoned any pretence of maintaining fiscal discipline. Marginal Treasury demand has been gradually shifting away from price-insensitive holders, such as the Federal Reserve, pension funds, and insurers, toward more sensitive buyers, like households, investment funds, and foreign private sector investors in recent years, and signs of stress are repeatedly emerging. Yesterday, a routine auction for 20-year debt saw yields pop to 5.014 percent – well above the recent 4.6-percent average – as demand from domestic buyers softened.

Bond markets elsewhere are beginning to offer a solid alternative for domestic and foreign investors, helping to redirect capital flows away from American financial markets. With the Bank of Japan gradually reducing its presence in fixed-income markets, 30-year Japanese government bond yields are climbing aggressively, long-term German rates are rising as the government plans a massive fiscal stimulus push, and British gilt yields are moving up in sympathy. On a global basis, long-end rates are moving higher.

Taken in sum, it appears that a worldwide competition for capital is underway, with profound implications for borrowing rates, government policy, corporate leverage, and household spending. Foreign exchange rates may enjoy a period of relative stability in the coming months, but another round of dislocations is on its way.

*These are very rough estimates, and should serve as a placeholder until the Congressional Budget Office, Penn-Wharton, and the Committee for a Responsible Budget update their models.

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