By Felix Martin
LONDON- “A billion here, a billion there”, Illinois Senator Everett Dirksen reputedly said of the US budget deficit in the mid-1960s, “and pretty soon, you’re talking big money”. The senator would need to do some swift recalibrations were he confronted with today’s American public finances. Last month, the Congressional Budget Office (CBO) reported that the federal budget deficit for the fiscal year ending September 30 had hit $1.7 trillion. That’s close to 7 percent of GDP. Shortly afterwards, the International Monetary Fund forecast that the deficit will continue at the same level for at least the next five years. Meanwhile, government debt has tripled since the senator’s day to around 120 percent of GDP.
Investors don’t appear to share Senator Dirksen’s sense of irony in the face of these gargantuan numbers. After climbing steeply throughout 2022 and then stabilizing in the first half of 2023, the market for US Treasury bonds has sold off sharply again in the last three months, aggressively pushing up yields on long-dated bonds. Recent trading sessions have teetered on the disorderly, with the 30-year U.S Treasury yield rising above 5 percent amid intraday swings of 20 basis points or more.
Demanding higher yields may be a rational response to swelling deficits and debt. Yet jittery investors also make the situation worse. Uncle Sam’s interest expenses leapt by a third to $711 billion in fiscal 2023 — more than the total bill for Medicaid and just shy of a year’s worth of defense spending. Unlike many corporations and households, the US government did not lock in the low interest rates of the last decade by issuing long-dated debt, preferring instead to skew funding towards bills and short-term bonds. That strategy has left it heavily exposed to the pain of higher rates. Last week, the legendary investor Stanley Druckenmiller dubbed it “the biggest blunder in the history of the Treasury”.
That may not be an exaggeration. The fear stalking financial markets is that the government of the world’s largest economy — and the issuer of its only true reserve currency — is at risk of falling into a debt trap, as a vicious circle of higher borrowing costs and larger deficits sends the stock of debt on an uncontrolled upward spiral.
That concern is beginning to catalyze a shift in the all-important market for US government bonds. Normally, investors in official American fixed income securities are primarily engaged in the humdrum business of pricing the Federal Reserve’s next policy moves. Now, they are trying to aim off for the existential question of whether the public debt is sustainable.