By Jamie McGeever
Long-term U.S. bond yields have recently taken center stage, with the yield on 30-year Treasury bonds surpassing 5%, nearing its highest level in two decades. But Washington is also grappling with a problem of short-term debt. Borrowing costs at the front end of the curve – for maturities up to two years inclusive – are soaring, approaching 4% or near that level, as the energy shock triggered by the war in Iran drives up inflation and dims the prospects for interest rate cuts by the Federal Reserve.
The rise in long-term yields – Wednesday’s 30-year bond auction sold at over 5% for the first time since 2007 – made headlines, but short-term yields actually climbed even more. The two-year yield has risen by 50 basis points this year, while the 30-year yield has increased by 20 basis points.
For a Treasury that must issue and refinance vast amounts of short-term debt, this is concerning.
U.S. short-term debt issuance has more than tripled over the past decade and now exceeds 100% of GDP, according to BlackRock analysts.
Treasury bond issuance in the first four months of this year totaled $9.14 trillion, approximately 85% of total Treasury borrowing. This is the highest share since the global financial crisis.
Issuing and refinancing short-term debt is a logical strategy in the presence of a “normal” yield curve, where short-term interest rates are lower than those on longer-term debt. But this approach also exposes the Treasury to higher financing costs, and the strategy seems less wise as the Fed moves towards raising interest rates and the yield curve flattens.
“If short-term Treasury issuance may be justified in the short term,” argues Joseph Brusuelas, chief economist at RSM US, “excessive reliance on this strategy opens the door to distortions in financial markets and increases the risk of rising costs in case of a surge in inflation.”
LET IT BE
None of this means that a crisis in American debt is looming. The risk of a buyer strike is low at the long end of the curve, and infinitesimal at the ultra-short end. There will be a long line of investors ready to buy U.S. Treasuries and two-year bonds in the world’s most liquid market in exchange for a 4% annual yield. The balance of over $8 trillion in U.S. money market funds attests to the massive appetite for U.S. Treasuries.
And let’s not forget that the Fed buys around $40 billion of Treasury bonds each month as part of its liquidity management to ensure sufficient reserves in the banking system.
The most realistic risk is that a vicious circle could emerge, restricting the U.S. government’s budget policy options.
Unless Washington starts reducing its spending or increasing taxes – a unlikely prospect regardless of the party in power in the White House – it will have to borrow more to honor its current and future commitments, and this refinancing and new borrowing will have to be done at even higher rates. Extrapolating, the long-term outlook is one of persistent and significant budget deficits and a high debt-to-GDP ratio.
Washington’s expenses on interest payments already accounted for almost half of last year’s $1.87 trillion in discretionary spending, and the non-partisan Congressional Budget Office forecasts that net interest payments for fiscal 2026 will exceed $1 trillion, more than the defense budget.
Furthermore, the rise in short-term rates could inadvertently worsen the budget deficit by increasing the cost of debt service, “potentially reinforcing the inflationary pressures they are supposed to contain,” wrote David Andolfatto, a professor of economics at the University of Miami this week.
He notes that the average rate on marketable federal debt at the end of last year was around 3.5%, nearly three times higher than five years ago. It is now higher and expected to continue to rise.
So, Treasury officials may not lose sleep over one or two disappointing debt auctions, but the spiral of financing costs from a growing public deficit could keep some awake at night.
(The opinions expressed here are those of the author, a columnist for Reuters)
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