The financial world is debating the limit of the market's appetite for U.S. debt, leading to concerns about funding government priorities. Traders' battle in the Treasury bond market resulted in a "buyers' strike" and raised interest rates. The ongoing debate centers on the potential economic consequences of growing federal debt and its impact on government spending.
Wall Street’s Bond ‘Vigilantes’ Are Back The financial world has been debating if market appetite for U.S. debt is near a limit. Not everyone agrees this is something to panic about, but the ramifications for funding government priorities are immense. Typically, the esoteric inner workings of finance and the very public stakes of government spending are viewed as separate spheres. But those separations and that sense of order changed this year as a gargantuan, chaotic battle was waged by traders in the nearly $27 trillion Treasury bond market. In the summer and fall, many investors worried that federal deficits were rising so rapidly that the government would flood the market with Treasury debt that would be met with meager demand. They believed that deficits were a key source of inflation that would erode future returns on any U.S. bonds they bought. In market parlance, they were acting as bond vigilantes. That vigilante mindset fueled a “buyers’ strike” in which many traders sold off Treasuries or held back from buying more. The yield on the 10-year Treasury note — the benchmark interest rate the government pays — went from just above 3 percent in March to 5 percent in October. Since then, momentum has shifted to a remarkable degree. Several analysts say some of the frenzy reflected mistimed and mispriced bets regarding recession and future Federal Reserve policy more than fiscal policy concerns. And as inflation retreats and the Fed eventually ratchets down interest rates, they expect bond yields to continue to ease. Federal debt held by the public — the amount of interest-generating U.S. Treasury securities held by bondholders — relative to gross domestic product neared peak levels during the pandemic. Under current law, growing budget deficits increase the amount of debt the federal government must issue, and higher interest rates mean payments to bondholders will make up more of the federal budget. Interest paid to Treasury bondholders is now the government’s third-largest expenditure, after Medicare and Social Security. Powerful voices in finance and politics in New York, Washington and throughout the world are warning that the interest payments will crowd out other federal spending. Fitch, one of the three major agencies that evaluate bond quality downgraded the credit rating on U.S. debt in August, citing an “erosion of governance” that has “manifested in repeated debt limit standoffs and last-minute resolutions.” The debate over public debt is as fierce as ever and has intensified debates over what the government can afford to do down the road. In the broader context of the interest rate controversy, there is disagreement on whether to even characterize U.S. debt as primarily a burden. Stephanie Kelton, an economics professor at Stony Brook University, is a leading voice of modern monetary theory, which holds that inflation and the availability of resources are the key limits to government spending. U.S. dollars issued through debt payments “exist in the form of interest-bearing dollars called Treasury securities,” said Dr. Kelton, a former chief economist for the U.S. Senate Budget Committee. David Kotok, the chief investment officer at Cumberland Advisors since 1973, argued that with some structural changes to the economy, a debt load as high as $60 trillion or more in coming decades would “not only not be troubling but would encourage you to use more of the debt because you would say, ‘Gee, we have the room right now to finance mitigation of climate change rather than incur the expenses of disaster.’” The Treasury can telegraph and rearrange the amount of debt that will be issued at Treasury bond auctions and determine the time scale of bond contracts based on investor appetite. The Fed can unilaterally change short-term borrowing rates, which in turn often influence long-term bond rates. For now, according to the Treasury Borrowing Advisory Committee, auctions of U.S. debt “continue to be consistently oversubscribed” — a sign of steady structural demand for the dollar, which remains the world’s dominant currency.
Wall Street’s Bond ‘Vigilantes’ Are Back The financial world has been debating if market appetite for U.S. debt is near a limit. Not everyone agrees this is something to panic about, but the ramifications for funding government priorities are immense. Typically, the esoteric inner workings of finance and the very public stakes of government spending are viewed as separate spheres. But those separations and that sense of order changed this year as a gargantuan, chaotic battle was waged by traders in the nearly $27 trillion Treasury bond market. In the summer and fall, many investors worried that federal deficits were rising so rapidly that the government would flood the market with Treasury debt that would be met with meager demand. They believed that deficits were a key source of inflation that would erode future returns on any U.S. bonds they bought. In market parlance, they were acting as bond vigilantes. That vigilante mindset fueled a “buyers’ strike” in which many traders sold off Treasuries or held back from buying more. The yield on the 10-year Treasury note — the benchmark interest rate the government pays — went from just above 3 percent in March to 5 percent in October. Since then, momentum has shifted to a remarkable degree. Several analysts say some of the frenzy reflected mistimed and mispriced bets regarding recession and future Federal Reserve policy more than fiscal policy concerns. And as inflation retreats and the Fed eventually ratchets down interest rates, they expect bond yields to continue to ease. Federal debt held by the public — the amount of interest-generating U.S. Treasury securities held by bondholders — relative to gross domestic product neared peak levels during the pandemic. Under current law, growing budget deficits increase the amount of debt the federal government must issue, and higher interest rates mean payments to bondholders will make up more of the federal budget. Interest paid to Treasury bondholders is now the government’s third-largest expenditure, after Medicare and Social Security. Powerful voices in finance and politics in New York, Washington and throughout the world are warning that the interest payments will crowd out other federal spending. Fitch, one of the three major agencies that evaluate bond quality downgraded the credit rating on U.S. debt in August, citing an “erosion of governance” that has “manifested in repeated debt limit standoffs and last-minute resolutions.” The debate over public debt is as fierce as ever and has intensified debates over what the government can afford to do down the road. In the broader context of the interest rate controversy, there is disagreement on whether to even characterize U.S. debt as primarily a burden. Stephanie Kelton, an economics professor at Stony Brook University, is a leading voice of modern monetary theory, which holds that inflation and the availability of resources are the key limits to government spending. U.S. dollars issued through debt payments “exist in the form of interest-bearing dollars called Treasury securities,” said Dr. Kelton, a former chief economist for the U.S. Senate Budget Committee. David Kotok, the chief investment officer at Cumberland Advisors since 1973, argued that with some structural changes to the economy, a debt load as high as $60 trillion or more in coming decades would “not only not be troubling but would encourage you to use more of the debt because you would say, ‘Gee, we have the room right now to finance mitigation of climate change rather than incur the expenses of disaster.’” The Treasury can telegraph and rearrange the amount of debt that will be issued at Treasury bond auctions and determine the time scale of bond contracts based on investor appetite. The Fed can unilaterally change short-term borrowing rates, which in turn often influence long-term bond rates. For now, according to the Treasury Borrowing Advisory Committee, auctions of U.S. debt “continue to be consistently oversubscribed” — a sign of steady structural demand for the dollar, which remains the world’s dominant currency.