At some point after a period of issuing short-term debt, the U.S. government will return to issuing longer-term debt. That moment will provide an acid test of investors’ estimation of risk associated with U.S. securities.
On Tuesday, after a federal appeals court on Friday ruled against U.S. tariff policy, the 30-year U.S. Treasury yield continued to show volatility, first increasing and then ending the day about even. The 30-year yield has now risen by 18 basis points since the start of the year.
How long that increase continues will depend on everything from the aggressiveness of the Treasury’s programs to the participation of foreign investors in the U.S. Treasury market.
The bond markets in Europe offer some perspective.
Given the move in long-term yields in the United Kingdom to multidecade highs, the ongoing political issues that are pushing yields in the E.U. higher and a general increase in debt issuance among the G-7 economies, September is shaping up as a possible inflection point in which the risk premiums associated with fiscal dominance among the large economies are likely to increase.
Even as central banks cut policy rates and push rates down at the front end of the curve, investors are demanding a greater premium for holding longer-dated debt.
The increase in yields at the long end of the curve is a result of investors questioning the credibility of central banks in holding the line on inflation.
In the United States, a steeper yield curve is increasing net interest margins for the banks, while also raising the cost of credit for businesses and consumers.
At the same time, real disposable incomes in the U.S. are declining and inflation-adjusted spending is slowing. In this environment, rising long-dated yields in the U.S. are not conducive to sustained growth as inflation moves the wrong way.
This combination will only cause investors to demand higher risk premiums for holding government debt.
This year, the yield on 30-year Treasury bonds has breached the 5% threshold or threatened to move above it on several occasions.
With the 30-year yield ending Tuesday at 4.97%, it seems clear that market participants are now requiring additional return on their investments to cover the uncertainty over inflation, economic growth and monetary policy.
Meanwhile, the yield on the 2-year Treasury has fallen this year, reaching 3.65% in anticipation of multiple rate cuts by the Federal Reserve.
The result has been not only the steepening of the U.S. yield curve but also a widening of the 30-year/2-year yield spread to 132 basis points, the widest since the pandemic-era distortions of the Fed’s near-zero interest rate policy.
That yield spread is an opportunity for bond traders to borrow at lower interest rates and invest in the long-end of the curve, helping to keep a lid on 30-year bond yields for now.
