Global Bond Turmoil: A Shift In Financial Markets Amid Rising US Deficits

A significant shift in the financial landscape is being mirrored in the recent turmoil in the bond market, with escalating US deficits playing a pivotal role.

What Happened: As highlighted by Greg Ip of The Wall Street Journal, despite peaking at 5% in the fall of 2023, the 10-year Treasury yield has returned to its level at the start of the year, sitting at 4.55%.

Ip wrote that the increase in yield this week is not indicative of a crisis or panic, but it does signal a shift in the financial markets. The days of abundant savings pursuing scarce bonds are over, leading to increased borrowing costs for governments around the globe.

The US stands out due to its yearly deficits, which are projected to surpass $2 trillion and could even touch $3 trillion.

“The trend is global, but the U.S. is an especially big piece of the story because of annual deficits likely to top $2 trillion on the way to $3 trillion, and the potential erosion of the dollar’s reserve status,” Ip wrote.

The dynamics of the bond market are shaped by several factors, including the Federal Reserve’s short-term interest rates and the issuance of additional government bonds.

Also Read: Federal Reserve Should Do ‘Nothing At All’ About The Rising Yields, Says Craig Shapiro: ‘Let The Bond Vigilantes Eat’

Ip wrote that since October, 2024, the term premium, which represents the extra return expected from a 10-year bond over holding Treasury bills for the same duration, has been on the rise. This suggests that investors are requiring higher returns for bond ownership.

Country-specific factors are also contributing to the situation. For example, Japan’s lackluster demand at a 20-year government bond auction triggered this week’s global bond upheaval. Germany is borrowing more for defense and infrastructure, while Britain is grappling with ongoing inflation.

The fiscal situation in the U.S. is also under scrutiny. The federal deficit surpassed 6% of GDP last year and is expected to exceed 7% for a decade under the budget plan approved by House Republicans earlier this week. This would set a record for the longest sustained period in U.S. history and outpace nearly all other advanced economies.

The decision by Moody’s Ratings last week to deprive the U.S. of its last triple-A debt rating highlights the country’s fiscal difficulties. Investors are now contemplating whether to cut back on their U.S. dollar assets after two decades of steady investment.

“Moody’s Ratings’ decision last Friday to strip the U.S. of its last triple-A debt rating told us nothing we didn’t already know. The U.S. is a fiscal train wreck, which we also knew in 2023, when Joe Biden was president, Fitch Ratings downgraded the U.S. and the 10-year bond yield touched 5%,” he continued.

Why It Matters: The current bond market turmoil and the U.S.’s increasing deficits have significant implications for the global financial landscape.

The shift from an era of abundant savings and scarce bonds to one of higher borrowing costs for governments could potentially reshape the dynamics of global finance.

Furthermore, US fiscal challenges and the potential impact on the dollar’s reserve status could have far-reaching effects on global investment patterns.