By Jamie McGeever
America’s long-term bonds have recently attracted all the attention, with the yield on 30-year Treasury bonds crossing the 5% mark and approaching its highest level in two decades. But Washington is also facing a short-term debt problem. Borrowing costs at the front end of the curve — for maturities up to two years inclusive — are soaring, settling at 4% or near that level, as the energy shock triggered by the war in Iran drives up inflation and dims the prospects of rate cuts by the Federal Reserve.
The rise in long-term yields — Wednesday’s sale of 30-year bonds sold at over 5% for the first time since 2007 — made headlines, but short-term yields have actually risen even more sharply. The two-year yield has increased by 50 basis points this year, while the 30-year yield has risen by 20 basis points.
For a Treasury that must issue and refinance huge amounts of short-term debt, this is worrying.
American short-term debt issuance has more than tripled over the past decade and now exceeds 100% of GDP, according to BlackRock analysts.
Treasury bond issuances in the first four months of this year totaled $9.14 trillion, representing about 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 security interest rates are lower than long-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 benchmark rates and flattening the curve.
“While short-term Treasury issuance can 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 higher costs in the event of inflation spikes.”
LEAVE IT TO HAPPEN
None of this means that a crisis in American debt is looming. If the risk of a buyer’s strike is low at the long end of the curve, it is infinitesimal at the ultra-short end. There will be a long line of investors ready to buy Treasury bonds and two-year bonds in the planet’s most liquid market in exchange for an annual yield of 4%. The balance of over $8 trillion in US money market funds reflects the huge appetite for US Treasury bonds.
And let’s not forget that the Fed purchases about $40 billion of Treasury bonds each month as part of its liquidity management to ensure sufficient reserves in the banking system. The most likely risk is that a vicious circle is set in motion, which could restrict the American government’s fiscal policy options.
Unless Washington starts reducing its spending or increasing taxes — an unlikely prospect regardless of the party in office in the White House — it will have to borrow more to meet its current and future commitments, and this refinancing as well as 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 spending on interest payments already represented nearly half of last year’s $1.87 trillion discretionary spending, and the nonpartisan Congressional Budget Office forecasts that net interest payments for fiscal 2026 will surpass $1 trillion, exceeding the defense budget.
Furthermore, the rise in short-term interest rates could inadvertently widen the budget deficit by increasing debt service costs, potentially “reinforcing the inflationary pressures they are supposed to contain,” wrote David Andolfatto, an economics professor at the University of Miami. He noted that the average interest rate on 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 is expected to continue to climb.
Treasury officials may therefore not lose any sleep over one or two disappointing debt auctions, but the spiral of financing costs for a growing public deficit could prevent some from sleeping.
(The opinions expressed here are those of the author, a columnist for Reuters)
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