Dwindling global reverence for United States government bonds - long regarded as the safest and highest quality place on earth to park money - is starting to eclipse uncertainty around tariffs as the single biggest issue facing the U.S. economy.
Growing cracks in the bond market – namely U.S. Treasurys – have seen investors and foreign governments alike demand higher compensation in exchange for what is shaping up to be a riskier loan environment for Uncle Sam.
Given that the U.S. is traditionally perceived to be extremely low risk, its yields (a la interest rates) tend to be low.
Spike in bond yields
However, in light of heightened global wariness for U.S. bonds, there’s been a recent spike in 30-year loans to their highest level in 30 years.
In other words, U.S. Treasury bond investors simply want a higher return to reflect the [perceived] greater risk they’re now taking on.
What has spooked buyers of U.S. government bonds is the deteriorating state of America's already debt-laden economy.
Pushing bond yields even higher were recent revelations that the Trump administration’s ‘Big Beautiful Bill’ – a proposed tax cuts and spending package – could add up to US$3.8 trillion to America’s existing debt.
To put investor angst into context, the U.S. government already owes its lenders around $36.2 trillion.
Added to investor anxiety, the response by U.S. Treasury Secretary Scott Bessent to the recent Moody’s downgrade of the U.S. credit rating to AA1 from AAA was - ‘so what?'
At current levels, this represents around 122% of the country’s annual economic output or gross domestic product (GDP) and is growing by about $1 trillion every three months.
If you haven’t already connected the dots, the revenue that the U.S. government receives is insufficient to service the interest on its current debt.
Interestingly, Moody’s recent downgrade of the U.S. credit rating coincided with a lacklustre 20-year U.S. Treasury bond auction.
This is seen as a resounding vote of no confidence in Washington’s economic stewardship.
The numbers suggest notable cracks in investors' demand with a bid-to-cover ratio of 2.46 and a yield of 5.047 percent — the highest in five years.
Where to from here?
In direct response to market jitters back in April – when Trump described bond markets as becoming “a little bit yippy” – the U.S president paused higher tariffs for 90 days.
What Trump’s yippy comment was referring to was the yield on the 30-year US Treasury - which moves inversely to the bond’s price - which rose 60 basis points and breached 5%.
In the last 25 years, the U.S. 30-year bond yield has only risen above 5% four times.
In two out of those four times, the U.S. markets (by extension, most global financial markets) have seen corrections of almost 50%.
Unsurprisingly, Trump’s decision to freeze tariffs was his first palpable admission that growing yields lead to growing debt - which leads to greater instability within the market.
Who will buy US bonds a year from now?
If bondholders run for the exit in large enough numbers – due to losing faith in the U.S. Treasury - and the bond market does crash, Trump knows all too well that the country is in serious trouble.
Another factor that’s also playing out in the background is the corresponding rise in Japanese yields.
The Japanese are big holders of U.S. debt outside of the U.S. and with yields moving sharply higher at home, some of that money could move back to Japan.
That means even less demand for U.S. bonds coming within a year when they will have a huge amount of debt to rollover and mature.
The $64,000 question now is how long Trump can stress-test the market before those investors want out?
Slow burning with high risk
Meantime, while Ray Dalio, founder of Bridgewater Associates doesn’t expect the U.S. economy to tank tomorrow, he’s part of a growing chorus of economists and institutional investors who have been sounding the alarm over the size of the U.S. deficit for years.
While Dalio sees “very low imminent risk” of a U.S. government debt crisis, over the long term it’s a different story, he writes in his new book “How Countries Go Broke: The Big Cycle.”
Dalio worries that the vast government debt will crowd out spending on essential services to leave a hollowed-out economy that can’t work for its citizens and this outcome clearly spooks global investors.
“Even though this progression has happened many times in history, most policy makers and investors think their current circumstances and monetary system won’t change,” Dalio writes.
“The change is unthinkable — and then it happens suddenly.”
Debt death spiral
Dalio is concerned that the U.S. could find itself in a self-perpetuating debt “death spiral.”
The debt “death spiral” Dalio’s talking about occurs when a higher deficit creates the need for Treasury to sell more bonds to finance its spending and interest payments on its existing debt.
However, when a debt spiral occurs, notes Dalio, it’s typically when a government experiences less demand for its bonds and has to pay investors more and more interest for them to bite.
“A spiral of rising interest rates leading to worsening credit risk, leading to less demand for the debt, leading to higher interest rates is a classic debt ‘death spiral’,” Dalio said.
This suggests to Dalio that U.S. policy makers should be more, not less, conservative in dealing with the government’s finances.
The worst thing possible, adds Dalio, would be to have its finances in bad shape during difficult times like these.
36-months
Based on the unsustainable debt path the U.S. currently faces - more than the market can bear - Dalio expects it will be roughly 36-months before America is in a “critical situation.”
“I think we should be afraid of the bond market,” Dalio said.
“I can tell you that this is very, very serious.”
Admittedly, tax cuts can be a boon for Wall Street, and the stock market cheered Trump’s tax cuts during his first term.
However, what makes this time different, notes Alan Auerbach, a professor of economics at UC Berkeley is adding to the deficit while the federal debt burden has ballooned.
“We’re now talking about deficits and a national debt-to-GDP ratio that are really going to be unprecedented, except for recent recessionary times,” said Auerbach.
“As markets absorb the details of the new tax bill and realise that deficits are likely to keep rising for the foreseeable future, the risk is that longer yields keep rising as well.”
Added to the dilemma confronting the U.S. neither the Democrats nor the Republicans have demonstrated that they can work together on this problem.
“It’s like being on a boat that’s headed for rocks,” Dalio said.
“…and they agree that they should turn, but they can’t agree on how to turn.”
