USA Bond Shock

Hi, welcome back to the channel. In today's episode I want to talk about the U.S. bond market because something quite significant appears to be changing. The yield on the 30-year U.S. treasury bonds has now risen to 5.3 percent. That's the highest level that we've seen since 2007 and that's a key date because it was the year before the global financial crisis. So America is now facing its highest long-term borrowing costs for almost 20 years. But I don't think the most important part of this story is simply that yields have gone up because there is now a clear sign that something else may be happening underneath the surface. Something appears to have shifted in the way investors are looking at long-term U.S. government debt and importantly this latest move can't simply be explained away by saying that markets are expecting the Federal Reserve to push interest rates dramatically higher. That isn't really what the market is now expecting. So the question is why are long-term borrowing costs continuing to rise and what exactly is the bond market becoming worried about? Because if this is no longer simply about the next Federal Reserve interest rate decision then potentially we're dealing with something much more concerning. And that matters enormously because the USA accumulated an extraordinary amount of debt during an era when borrowing costs were dramatically lower than they are today. Some of that debt was financed at one percent, two percent, three percent and as those bonds start to mature the U.S. government has to refinance them. Except it isn't refinancing them with the cheap environment money that existed for much of the last two decades, it's refinancing them in today's market where long-term borrowing costs are significantly above five percent. And at exactly the same time the U.S. continues running huge budget deficits which means the government doesn't simply need the money to refinance the old debt, it also needs to create new debt as well. So potentially you've got old cheap debt gradually becoming replaced by more expensive debt while enormous quantities of new debt are also being issued at these higher rates. And when you combine that with this apparent change in the behavior of the bond market I think this becomes one of the most important economic stories that's going around today. So in today's video I want to show you exactly what's happening, why the latest move looks different to what we've seen before and why the bond market may now be sending a warning that goes well beyond the next interest rate decision. But before we get into all of the details, if you're enjoying my economic updates could you please give this video a thumbs up, please subscribe to the channel if you haven't done so already and if you can see that funny little hype symbol that sits just alongside from the thumbs up symbol hit that as well please, it really does help me with the algorithm, it helps to promote this video to more people that haven't seen my videos before and also puts a smile on my face. Okay so for anybody that's interested in graphs I've got some good news, let's have a look at some of the graphs of this story. This graph shows the yield on the 30-year US treasury bond over the past 10 years and as you can see immediately things have changed dramatically. There were long periods when the treasury bond yield was sitting at around three percent, it then fell to around two percent and during the extraordinary period of ultra cheap money they went even lower to around one percent. But that entire trend has now reversed as you can see from the graph. The yields rose to two percent and then they increased past three percent, they increased past four percent and now they are sitting above five percent and the latest issuance is around 5.3 percent. As I said earlier that is now the highest level that the US has seen for its borrowing costs since 2007. So the borrowing cost of the United States has more than doubled compared to the rates that we were seeing just a few years ago. Now let's pull the graph right back because I think this is where the story becomes really interesting. This graph shows the 30-year treasury yield for the USA all the way back to 1977 and obviously if you look at the left hand side you can see some extraordinary numbers. During the late 70s and early 80s inflation was rampant and interest rates were dramatically higher than they are today. So I'm not suggesting that a yield of 5.3 percent today is unprecedented, it clearly isn't. But look at the right hand side of this graph because that's what matters now. We're now back at the highest yields for 20 years which means that virtually the entire period since the global financial crisis has been characterized by And during that period the US issued trillions and trillions of dollars of debt. Some of those bonds issued when rates were incredibly low. Now obviously not all of America's debt pile suddenly gets repriced today. If the government issued a long-term bond years ago at a low coupon it continues paying that low coupon until that bond matures. But eventually all bonds mature and when they do the government needs the money to repay it or they have to refinance it. This is where the math becomes uncomfortable. If you think about the US issuing 100 billion dollars of debt at two percent, very simplistically that debt will cost the US two billion dollars per year in interest. If that debt matures and has to be refinanced at five percent you're suddenly looking at something that's going to cost five billion dollars per year. The same billion dollars of debt more than twice the annual interest cost. Move from one percent to five percent and you're talking five times the amount of interest payable on that debt. Now obviously that's a very simplified illustration but it hopefully gives you an understanding as to what the US is facing right now. Treasury securities have different maturities, different coupons, and different structures basically dependent upon what the market was saying at the time when they were issued. But the principle is exactly the same. The US has accumulated an enormous amount of debt during a cheap money era and gradually that debt is rolling into a much more expensive refinancing environment. That's why this long-term graph matters. It isn't simply telling us that yields have risen, it's showing us that the US may be moving from one financing era into another. And then you've got the second problem. The US isn't simply refinancing existing debt, it's continuing to borrow even more money. The federal government continues running a very large budget deficit, spending more than it's earning. So the treasury has to refinance maturing debt and also finance new spending at exactly the same time. That means the issuance of more bonds, more supply of that type of debt, more capital required from investors, and potentially higher yields to persuade those investors to keep absorbing that supply of debt. And this is where I think the latest developments become particularly interesting because normally when treasury yields move sharply higher people immediately look towards the Federal Reserve and say the market must be expecting higher interest rates. And sometimes that's usually the situation. If investors think the Fed is going to tighten policy aggressively, short-term bond yields will normally rise. Longer-term yields will also rise over time. But that explanation doesn't fit with what we're seeing now. Expectations surrounding the Federal Reserve have actually become more stable. The latest economic data has become softer in a number of different areas. Growth concerns have increased. The labour market has shown signs of weakness. And the broad expectation is that the Federal Reserve is likely to leave rates relatively unchanged for the rest of 2026. So if investors were simply pricing against the Fed you might expect the pressure on bond yields to ease. You'd even expect long-term yields to start falling. But that's not what's happening. The 30-year yield is actually pushing higher. And I think that's the critical part of today's video because it suggests that investors are increasingly worried about something beyond monetary policy. They're not simply asking what's the Fed going to do at the next meeting. They're asking much bigger questions. What will the US inflation look like over the next 10, 20 or 30 years? How large will the national debt become? How large will future budget deficits be? How much additional treasury debt will investors be expected to absorb? And what return do they need to compensate them for all of those issues? That is a completely different type of concern. And I think it explains why the long end of the bond market is becoming so important. The Federal Reserve can exert enormous influence over short-term interest rates. But the Fed doesn't dictate the yield on 30-year treasury bonds. Investors do. And those investors are currently demanding around 5.3% which as I've said is the highest level since 2007. And that tells us that the market is becoming increasingly uncomfortable with the long-term picture. Inflation is one part of that. Oil is another. The war in Iran is continuing to create uncertainty surrounding energy supplies. And the risk of inflation will stay higher for longer. And that matters enormously to somebody lending money for 30 years. Because if inflation remains elevated, the purchasing power of the dollar they receive in the future is going to be worth less. So investors therefore demand a higher yield as compensation against that future inflation. Then you've got America's fiscal policy. The national debt continues increasing. Budget deficits remain enormous. Interest rates are rising. And the treasury has to issue huge amounts of debt just to keep everything financed. That creates another problem. Supply. If the government wants to sell more bonds, somebody has to buy them at simple supply and demand. And if investors become less enthusiastic, the simplest way to attract them is to offer a better return. In other words, increase the yield. And that's why I think the latest move is different. We're not simply watching the bond market mechanically follow the Federal Reserve. We're potentially watching investors demand a larger premium for lending money to the US government for longer periods of time. That is a much more significant development. Because if that premium remains elevated, the consequences start feeding through the entire economy. Mortgage rates are influenced by long-term treasury yields. Corporate borrowing costs are also influenced by them, as are commercial property financing, private equity, consumer finance, and ultimately the stock market. So even if the Federal Reserve leaves official interest rates unchanged, financial conditions can still tighten. The bond market can effectively do some of the tightening itself. And I think that's one of the most important things for people to understand. People often talk about interest rates as though there's one single rate controlled by the Federal Reserve. But that's not how it works. The Fed controls very short-term policy rates. The market determines the price of money further out along the curve. And right now the longer end is sending a very different message. The Fed may be relatively steady, but 30-year borrowing costs are rising. That means the bond market is worried about something else. And I think that something else is increasingly the combination of inflation risk, fiscal deficits, rising debt, enormous bond issuance, and uncertainty about the long-term trajectory of US government finances. And this is where the refinancing problem comes back into the story. Because the higher these yields remain, the more expensive it becomes when existing debt matures. Again, this isn't overnight pricing. The entire 40 trillion debt pile that the US has suddenly doesn't reset to 5%. But gradually, month after month, year after year, lower cost debt rolls off and new debt replaces it. If that process continues at 4% or 5% or even higher, the average cost of America's debt will rise over time. And because the debt pile itself is so enormous, even relatively modest increases in the average debt rate can translate into extraordinary amounts of additional government expenditure. And then the feedback loop begins. Higher interest costs increase government expenditure. That can increase the deficit. A larger deficit requires more borrowing. More borrowing means more treasury issuance of bonds. More treasury issuance means investors have to absorb even more bond supply. And if investors want a higher return to absorb that supply, yields then rise further. That's the risk and that's the loop. And this is why simply looking at the Federal Reserve no longer tells you the whole story. The more interesting question now is what the bond market itself is saying. And right now, it appears to be saying, we want to be paid more to lend the US money for 30 years. That's a very different message from simply pricing another quarter point move from the Fed. And I think this is why the latest move deserves attention. Because if the 30 year yield remains above 5%, or continues moving higher to maybe 5.5%, we're entering territory that an entire generation of investors has barely experienced. And the consequences could be spread far beyond Washington. Higher government borrowing costs, higher mortgage rates, higher corporate borrowing costs, more pressure on businesses, more pressure on commercial property, potentially even more pressure on equity valuations, and ultimately more pressure on the federal budget. So overall, I think there are two stories developing here. The obvious story is that the 30 year treasury yield has reached its highest level since 2007. Hopefully everybody's got that message already. But I think the more important story is the question of why. Because this latest move appears increasingly difficult to explain simply by saying that investors are expecting the Fed to raise rates. Expectations are that the Fed are going to keep rates level, yet long term yields are still rising. That suggests the market is becoming increasingly concerned about long term risks for surrounding the US's finances. And if that's what we're seeing, then this isn't simply another interest rate story. It's potentially something much bigger. So hopefully you've enjoyed today's video. You found it useful, informative, most importantly, thought provoking. If you have liked what I've said, or maybe you didn't quite like it, but you thought it was interesting, then please give me a thumbs up. Please hit the like button if it's available to you and subscribe to the channel if you haven't done so already. I really appreciate all of that support for this video and the channel overall. 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