Rebellion of the Bond Market
While all eyes are focused on the rising stock market, the bond market is staging a quiet rebellion. Interest rates are rising inexorably, despite pronouncements from Fed Chair Jerome Powell that there is no inflation in sight, at least for the next three years.
Still, bond buyers are demanding slightly higher interest rates, especially when it comes to buying longer-dated bonds. The 10-year Treasury note, which briefly yielded a shockingly low 0.54% in the depths of the pandemic, has risen to 1.5% recently.
In the bond world, that is a huge move upward in yield. When the world was literally falling apart last spring, those seeking safety were willing to accept very low yields in exchange for the security of owning U.S. government debt. Now, not so much.
While you might not care much about the intricacies of the multi-trillion dollar government bond market, it will impact you, whether you’re a saver, a spender or a younger American who will have to work and pay taxes to pay the interest on our national debt down the road. So, it’s worth paying attention.
MEGO numbers – My Eyes Glaze Over!
Here’s a startling fact. Last year the government spent $345 billion just paying interest on the national debt. Interest on our debt equaled 5.3% of total federal spending. Because of low interest rates, the interest burden was manageable. But our national debt will grow by $2 trillion this year. It has been conservatively projected that interest payments will cost the government $914 billion in 2028. That’s nearly $1 trillion in one year!
Interest on the national debt will become the largest category of government spending by 2048 — larger than Social Security and Medicare. So while the debt may be manageable at today’s low rates, if bond buyers demand more interest to buy our IOUs, the cost will be enormous.
Why rates rise
Rates rise out of fear that the future value (buying power) of a currency will erode. We call that inflation. Those concerns are priced every week as the Treasury borrows more money, by selling bills notes and bonds. Fear or optimism are priced around the clock in the huge global bond-trading market.
Interest rates may also rise out of optimism that future growth will get the economy moving again, creating demand for money. Some of the current rise in rates comes from the success of the coronavirus vaccine and estimates that growth will resume. More economic activity would generate more tax revenues, cutting the need for government spending and perhaps lowering our budget deficits.