Investor attention is being drawn to the government’s mounting debt as a result of the Treasury-bond selloff that rocked US markets this month.
Investors are already becoming concerned about the country’s accelerated debt growth in 2023. In June, lawmakers came dangerously close to a catastrophic default due to an 11th-hour agreement mediated by President Joe Biden and former House Speaker Kevin McCarthy to raise the federal borrowing limit.
Some of the most well-known figures on Wall Street are now hinting that the disaster in Treasurys that has caused benchmark rates to reach 16-year highs may have been aided by “bond vigilantes,” who sell off fixed-income assets in an effort to thwart what they perceive to be reckless policies.
The government has been borrowing more and more money to finance its spending plans ever since the Second World War ended.
The national debt of the United States exploded from less than $300 billion in June 1946 to an astounding $33 trillion by September 2023, according to historical statistics from the Treasury Department. This means that the country’s obligations currently exceed the combined GDP of China, Japan, Germany, India, and the United Kingdom.
Economists believe that the significant surge in debt is a result of a number of factors, including tax cuts during the Reagan-Bush administration, the enormous expansion of the Treasury-bond market, and flashpoints like the financial crisis and the war of Iraq.
A rift has also emerged in Washington due to the government’s ever-increasing repayment obligations; prominent hard-right Republicans such as Florida governor Ron DeSantis and Rep. Matt Gaetz have voiced their opposition to the Biden administration’s student loan relief initiatives as well as May’s debt ceiling compromise.
The US debt-to-GDP ratio, which gauges the deficit level in relation to the size of the US economy overall, has likewise been gradually increasing since 2000 and crossed 100% for the first time in 2019, according to statistics from the International Monetary Fund.
That threshold, in the opinion of Capital Group economist Darrell Spence, is when a nation may have to begin to worry about its budget deficit slowing down general growth.
“When total debt exceeds GDP by 100%, will issues arise immediately? Most likely not However, he cautioned that taking on additional debt might push the government to raise taxes, saying, “US debt dynamics are evolving in a way that requires attention.”
Whether any of this is really relevant is still up for dispute.
Some believe that the US government should be allowed to continue amassing debt, certain that the country’s greatest economy and the dollar’s standing as the world’s reserve currency will protect it.
However, recent developments indicate that investors’ confidence in the US’s ability to repay its obligations may be eroding.
One of the worst crashes in market history has caused the price of Treasurys to plummet, pushing rates on 10-year notes and 30-year bonds above 5% for the first time since 2007.
The sell-off has been fueled by investors’ expectation that the Federal Reserve would maintain borrowing costs high long into 2024 in an effort to combat inflation, since rising interest rates make bonds’ guaranteed yields but low risk less appealing.
However, others on Wall Street think that bond vigilantes, or activist traders, are partly responsible for the market collapse. These traders attempt to drive down Treasury prices in an effort to pressure Congress into changing its borrowing practises.
Veteran economist Ed Yardeni, who popularised the term “vigilante” in the 1980s, stated in September that “people have been focusing on the deficit issue ever since the government debt was downgraded on August 1.”
I believe we’re going to have a serious issue, and it could take the mobilisation of my friends, the bond vigilantes, to persuade lawmakers that we need to take more fundamental action to improve the long-term prognosis for the deficit,” he continued.
Bill Gross, the “bond king” and co-founder of PIMCO, has made billions of dollars trading this asset class, and he is also supporting the vigilante theory. Earlier this month, he stated that it was possible that a group of retail traders had taken the market hostage and pushed rates towards 5%.
Investors should be concerned if debt is contributing to a moment of market turmoil. The deficit is predicted to continue growing by trillions of dollars annually.