The start of the Federal Reserve’s rate cuts last month was expected to push bond yields lower – and take some pressure off the rising US debt burden.
Last month, Torsten Sløk, chief economist at Apollo Global Management, noted that with US debt now at $35.3 trillion, interest costs are averaging $3 billion per day. That’s up from $2 billion about two years ago, when the Fed began its rate-hike campaign to rein in inflation. At the time, he was hopeful about expected Fed rate cuts.
“If the Fed cuts rates by 1 percentage point and the entire yield curve falls by 1 percentage point, daily interest costs will drop from $3 billion per day to $2.5 billion per day,” Sløk estimates.
So far it doesn’t work that way.
To be fair, government bond yields plummeted ahead of the first rate cut as investors looked for an aggressive easing cycle to match the aggressive tightening cycle.
But since the Fed’s policy meeting concluded, rates have risen, and some Wall Street forecasters have warned that the central bank could even hold off on further cuts.
That’s because Fed officials and economic data have dampened optimism about many cuts. First, the so-called ‘dot plot’ of policymakers’ interest rate projections tended towards slightly less easing than the market expected.
Then, at the press conference after the meeting, Fed Chairman Jerome Powell said the massive half-point cut was not necessarily indicative of the pace of future cuts. A week later, he warned that Fed officials are in no rush to cut rates further.
Then last week’s successful jobs report pointed to a still-robust economy in need of many workers demanding higher wages. And finally, the latest report on the consumer price index shows that inflation is cooling down, but is still somewhat more persistent than expected.
As a result, 10-year Treasury yields rose about 50 basis points from before the Fed meeting through Friday and are now near 4.1%. The 2-year government bonds are not doing much better: they have risen by about 40 basis points in that period to about 3.95%.
These yields influence the Treasury Department’s auctions of new U.S. debt needed to cover massive budget deficits, which are also driven in part by the rising cost of servicing U.S. debt.
For the federal budget year ending September 30, the budget deficit was $1.8 trillion, and interest costs on the U.S. debt were $950 billion, an increase of 35% over the previous year, mainly due to higher interest rates.
Government bond yields could fall again, especially if the labor market shows signs of significant weakening. But even if the Fed’s rate cuts ease pressure on interest payments, the next president is expected to worsen budget deficits, increasing the pile of overall debt and wiping out some of the benefits of lower rates.
A recent analysis by the Penn Wharton Budget Model even shows that the budget deficit will increase under Donald Trump or Kamala Harris. Under Trump’s tax and spending proposals, primary deficits would increase by $5.8 trillion on a conventional basis and $4.1 trillion on a dynamic basis over the next decade, including the economic effects of fiscal policy.
Under the Harris administration, primary deficits would increase by $1.2 trillion on a conventional basis and $2 trillion on a dynamic basis over the next decade.
This story originally appeared on Fortune.com
