What the bond market says about Congress, the national debt and the middle class – and where America goes from here
The bond market is reassessing the federal government’s fiscal madness. Congress knows it can’t reach the middle class and has no idea how to help them other than through more debt – and it’s headed for a bad outcome thanks to bond vigilantes. The 30-year Treasury yield closed at 5.62% on September 30, a level last seen in 2002. The 10-year yield is near 5.3%. The consequences for the budget are serious. Interest on the national debt reached $857 billion in the first nine months of the fiscal year, more than the government spent on Medicare or national defense. Before reacting, Washington must understand what the market is really saying.
One possible explanation is that investors are losing confidence in the dollar. Gold has more than doubled in two years. Commentators speak of a “depreciation trade,” in which bondholders flee paper debt ahead of expected inflation. From this point of view, rising yields and record gold prices are two symptoms of the same disease: Uncle Sam is printing dollars to cover his debt.
It’s a neat story, but other data refutes it. A bond yield has two components: expected inflation and the inflation-adjusted real yield. Comparing conventional Treasuries with inflation-protected securities allows us to separate the two. The 30-year breakeven inflation rate, the market’s long-term inflation forecast, stands at nearly 2.3%. This is nothing remarkable. The 30-year real yield, by contrast, has climbed above 3%, its highest level since before the 2008 financial crisis. Bondholders expect the dollar to hold its value fairly well. What has changed is the real price of government funding.
Supply and demand explain why the federal government is running deficits close to $1.9 trillion, while the Congressional Budget Office projects larger deficits. Meanwhile, private demand for capital increases. The development of artificial intelligence requires huge borrowing for data centers, chips and electric power. Public deficits and private investments compete for the same savings pool. When the demand for savings exceeds the supply, its price increases. This price is the real interest rate.
Some of this is good news. Real returns generated by productive investments indicate a growing economy. But deficits of this magnitude stifle investments that would improve future living standards. Even worse are arithmetic compounds. Higher yields increase debt servicing costs, which worsen deficits, requiring even more borrowing at those same higher yields. A long-term real return of 3% means that capital scarcity is binding again. Near-zero rates from 2008 to 2020 taught borrowers, and especially Congress, to view capital as fundamentally free. Those days are over.
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