The federal government is running on a hamster wheel of debt, refinancing trillions of dollars each month and borrowing trillions more in new loans in just a few months.
To prevent interest costs on $39 trillion in debt from ballooning further, the Treasury has relied heavily on short-term securities, which have lower yields than longer-term bonds.
In fact, according to Capital Economics, about 85% of debt issued in recent years has been Treasury bills with a maturity of one year or earlier. As a result, 20% of outstanding federal debt will come due in the next four months – and that share will reach 33% within a year.
“The biggest risk to debt burdens would therefore be a sharp rise in short-term yields if the Fed were to raise interest rates more than expected next year,” Ariane Curtis, senior North America economist at Capital Economics, wrote in a note late last month.
Since then, the Federal Reserve has become even more hawkish on interest rates. New Fed Chairman Kevin Warsh has taken a tough stance on inflation lately, and other policymakers have signaled they can no longer tolerate the current inflation rate, which has been above the central bank’s 2 percent target for five years.
On Friday, Cleveland Fed President Beth Hammack pointed out that inflation was too high and that the job market was “about at my maximum employment level,” suggesting greater concern about prices versus jobs.
“For the first time in my term, I’m hearing a growing sense of desperation from companies that I think need to take action to curb inflation and from consumers who can’t make ends meet,” she added Social media post.
Her warning came even as the latest consumer price index fell short of expectations, easing fears that the Fed may have to raise interest rates later this month.
However, the overall trend is for the Fed to become more hawkish as the economy has remained resilient and half of policymakers predict interest rate hikes soon. This is what analysts called for Bank of America to change their Fed forecast Increases of three quarter points this yearcompared to a previous baseline scenario in which interest rates remain stable until 2026.
Additionally, the collapse of the US-Iran ceasefire last week has caused oil prices to rise again, and the national average for a gallon of gasoline is back above $4.
Higher energy prices will increase cost pressures from the AI boom, which has made everything from electricity bills to consumer electronics to construction more expensive.
The Treasury has huge borrowing needs, with a projected annual budget deficit of $2 trillion, but at the same time is facing increased competition in the bond market, which has already pushed up yields to attract enough demand.
Hyperscalers issue one Flood of debt to fund hundreds of billions of dollars in AI spending. And even the historically stingy German government is ending decades of fiscal restraint with plans to borrow 800 billion euros by 2030 to upgrade its military.
investor Demand is also decreasing. Hoisington Investment Management, a bond manager that has been bullish on government bonds for more than 30 years, finally changed its stance, citing the prospect of higher inflation and yields.
The quarterly report said soaring U.S. debt has led to investors “increasingly demanding a higher risk premium for government bonds.”
For now, Capital Economics doesn’t believe a recent rise in Treasury yields alone will shake market confidence in the federal government’s ability to service its debt, even though interest costs are already at $1 trillion a year.
“But the longer yields remain high and the more debt is refinanced or issued at these levels, the more unsustainable the debt path becomes,” Curtis warned. “And as bond markets become increasingly sensitive to high levels of leverage and concerns about fiscal credibility in advanced economies more generally, fiscal risks remain significant.”