In a surprising turn of events, the bond vigilantes, who are large institutional investors that typically crack down on governments with big deficits, are currently missing in action. Despite the US government running up massive debt in recent years, bond markets seem unconcerned. The US federal deficit is projected to be 6.1-7.1% of GDP next year, which is much higher than other advanced economies. The International Monetary Fund (IMF) has warned that the US fiscal deficits have stoked inflation and pose significant risks for the global economy. However, forecasters expect yields to ease over the next couple of years. The debt vigilantes may stage a comeback if interest rates remain higher for longer.
The concerns raised by fiscal hawks about the increasing debt and interest rates in the United States are proving to be accurate. As interest rates rise and bondholders become less interested in buying U.S. debt, the warnings of fiscal hawks are gaining credibility. The theories put forth by economists such as Olivier Blanchard, Lawrence Summers, and Jason Furman, who argued that low interest rates and investment opportunities would mitigate the impact of debt, have failed to consider the long-term consequences of growing debt and the potential for higher interest rates.
The US government must address its debt problem and avoid the potential consequences of unchecked borrowing. The risks of high debt include slower economic growth, inflation, and the burden of interest payments. Fiscal responsibility is crucial to maintaining stability and avoiding future economic crises.
Despite falling yields in recent years, bond vigilantes are still present and can influence the bond market. The Federal Reserve's bond-buying program has suppressed yields, but if inflation rises, bond vigilantes could reemerge and push yields higher. The bond market is closely watching the US government's fiscal policies and the potential impact on bond yields. Monitoring bond vigilantes and their potential influence on the bond market remains important.
Bond vigilantes' reaction to French politicians' spending serves as a reminder for the US that the market will determine the tipping point for debt sustainability. Financial executives and investors have expressed concerns about growing US fiscal deficits, but bond markets have been relatively calm due to the strength of the US economy and its attractive markets. However, the French experience shows that bond vigilantes can suddenly react to fiscal plans, and there is an increasing risk of this happening in the US. Investors may start paying more attention to policy discussions following the first debate between Joe Biden and Donald Trump. The scale of the US deficit is increasing, and investors have been charging more for the debt issued by the US government. The difference between 30-year Treasury bond yields and the SOFR swap has increased, indicating that investors are demanding higher yields for US debt. The executive interviewed believes that debt will become a problem within the next five years, and possibly within the next ten years. Bond vigilantes' reaction to French politicians' spending serves as a cautionary tale for the US. The market will likely determine the tipping point for debt sustainability, and it will be hard to predict. While financial executives and investors have expressed concerns about growing US fiscal deficits, bond markets have remained relatively calm, focusing on the Federal Reserve rate outlook, inflation, and the economy. However, the risk of bond vigilantes waking up in the US is increasing, with some expecting policy outlook to start influencing the market following the first debate between Joe Biden and Donald Trump. The French experience shows how worries about fiscal plans can cause yields to spike. A senior financial industry executive believes that the signal of debt hitting an inflection point may come from the market, possibly after the debate. The scale of the US deficit problem is growing, with the Congressional Budget Office increasing its cumulative deficit forecast for the fiscal 2025-2034 decade by $2.067 trillion. Investors have been charging more for US government debt, as reflected in the higher yields on 30-year Treasury bonds compared to the SOFR swap. In contrast, German government bond yields are lower than the equivalent interest rate in Europe, reflecting better fiscal discipline. While many people believe that debt will become a problem within the next five years, no one has been rewarded for making that bet yet.
The increased likelihood that Donald Trump will regain the presidency has seen bond yields spike and the yield curve steepen. Trump's proposed policies, including tax cuts, tariffs, and immigration restrictions, have bond vigilantes worried. The vigilantes have been on the sidelines since the global financial crisis, despite rising US deficits and debt. Trump's policies, if implemented, would be disruptive and potentially damaging to the US and global economy. The bond vigilantes are concerned about the impact on deficits, debt, and inflation. They are also wary of Trump's attempts to influence the Federal Reserve and control interest rate moves. If the Fed isn't able to drive up interest rates in the event of a new outbreak of inflation, the bond vigilantes may take matters into their own hands.