US debt is in a much more difficult state than official figures indicate, while rising government bond yields are now causing severe concern on Wall Street. "All hands on deck" to prevent a new spike in long-term US borrowing costs, warns a top economist. The US Treasury market has shown troubling signs recently, with rising yields indicating that the situation may be far more serious than it appears, according to Robin Brooks, senior fellow at the Brookings Institution. In a post on Substack, Brooks argued that US economic policy has now shifted toward preventing another sharp rise in long-term borrowing costs. As he points out, characteristic of this shift are efforts by Treasury Secretary Scott Bessent to double down on bond buybacks, as well as Federal Reserve Chair Kevin Warsh's speech at Jackson Hole, in which he attempted to reassure markets regarding his credibility in the fight against inflation.
"All hands on deck" for bond yields
The most alarming element, according to Brooks, is that economic data showing a slowdown in activity has failed to cool down long-term yields. This development contradicts historical market patterns. Normally, when economic data deteriorates, investors price in lower growth and lower inflation, causing bond yields to drop. This time, however, the exact opposite is happening. Yields continue to climb. "As far as I can tell, this is an 'all hands on deck' situation regarding long-term yields," Brooks wrote characteristically.
Market ignores weak economic data
Despite Friday's jobs report positively surprising the market, other economic indicators over the past month have repeatedly missed expectations to the downside, according to Brooks. Under normal circumstances, this should lead to lower yields, as the market would price in an economic slowdown and cooling inflation. However, Treasury yields remain on an upward trajectory. One factor weighing on the picture is the US war with Iran, which has escalated in recent weeks. With conflict intensifying and no diplomatic solution in sight, crude oil prices have begun rising again, placing pressure on the outlook for inflation.
The 10-year Treasury sends warning sign
For Brooks, however, the truly concerning element is the "abnormal" behavior of the 10-year Treasury yield. This development, according to him, is an indication that demand for US debt is weaker than it appears at first glance. The 10-year Treasury yield has reached 4.74%, as investors demand higher compensation to continue funding the American government. And the problem is growing larger. US debt has now reached approximately $40 trillion, overshadowing even the artificial intelligence boom as a primary source of concern on Wall Street.
It is not just the US – Global alarm in the bond market
Concerns over debt are not limited to the US. Government bond yields are also rising in other major economies, including Great Britain, France, Germany, and Japan. The problem is that governments, following the COVID-19 pandemic, continued spending as though borrowing costs were still at historical crisis lows. At the same time, they allowed fiscal deficits to balloon, as if economies still required emergency support measures. However, the economic environment has now changed dramatically. Interest rates have risen significantly in recent years to combat high inflation, while the AI boom injects hundreds of billions of dollars annually into an economy that appears increasingly resilient to higher interest rates.
"When markets say debt is unsustainable"
The question now is precisely when US debt will be deemed unsustainable by financial markets. Joseph Brusuelas, Chief Economist at RSM, made a striking point in a note last month: "When does debt become unsustainable? When global financial markets say it is. That appears to be happening." This warning comes at a time when the composition of Treasury buyers is undergoing a fundamental shift.
Foreign investors abandon Treasuries and turn to gold
Foreign central banks and other institutional investors who traditionally used US bonds as a safe haven have scaled back their presence in the Treasury market. Instead, they are increasingly turning toward alternative havens, most notably gold. A prime example is Norges Bank Investment Management, the world's largest sovereign wealth fund, which manages roughly $2.3 trillion. The fund has proposed restructuring its government debt holdings, reducing its exposure to US Treasuries. Hedge funds are stepping into the shoes of traditional buyers. As traditional buyers of US debt retreat, hedge funds are assuming a larger role in the market. However, this transition comes at a cost. Hedge funds are far more sensitive to price fluctuations, which can significantly amplify market volatility in government bonds. This means the US Department of the Treasury must offer more attractive yields to keep investors engaged in the market. And that is where the trap lies.
$2 trillion deficit – Wall Street grows fearful
The US fiscal deficit is heading toward $2 trillion annually, with no clear sign that Congress is willing to curb spending. As a result, the market is becoming increasingly nervous about the prospect of continuing to lend to the US government on such a scale. For Brooks, the decoupling of bond yields from economic data points to an "obvious explanation": Markets are now placing greater weight on fiscal deficit projections, thereby driving long-term rates higher. "The underlying dynamic in the Treasury market is more concerning than you think," he warned.
The opposing view: No debt crisis incoming
There is, however, a counterpoint. Wall Street veteran Ed Yardeni dismisses warnings of an impending debt crisis. In his view, rising yields do not necessarily signal an imminent crash in the bond market. Instead, he believes yields are simply returning to more "normal" levels, akin to the period before the Great Financial Crisis and the COVID-19 pandemic, when the global economy entered an era of ultra-low rates. Yardeni acknowledges that the current trajectory of US debt is unsustainable. However, he estimates that the so-called "bond vigilantes"—investors who punish fiscally irresponsible governments by demanding higher yields—are not yet alarmed to a degree that would herald a full-blown crisis.
The critical threshold for the 10-year Treasury
"Treasury yields remain within a range that is broadly compatible with a healthy economy," Yardeni assesses. He predicts that the 10-year bond yield will hover between 4% and 5%. However, the question weighing heavily on markets is whether rising yields represent a return to "normalcy" or the first genuine warning sign that the market is demanding a far higher price to fund US government borrowing. In an economy carrying nearly $40 trillion in debt and an annual deficit nearing $2 trillion, this is a issue that Wall Street can no longer ignore.
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