May 21, 2024

QuickTakes

Is A US Government Debt Crisis Imminent?

Stock investors have been less “tarrified” about President Donald Trump's tariffs since April 9, when he postponed most of his proposed reciprocal tariffs by 90 days (chart). However, they may now be getting spooked that the bond market might be on the verge of a debt crisis, especially after Moody's downgraded US government debt on Friday and Japanese bond yields soared in recent days. The S&P 500 fell 1.61% today, mostly after the sloppy results of the 20-year US Treasury auction.

In addition, the 30-year US Treasury bond yield closed above 5.00% today for the first time since late October 2023 (chart). The 10-year yield is still well below its October 2023 peak, but the financial press rang the alarm bell about the 30-year yield exceeding 5.00%.

Furthermore, stock and bond investors may be starting to get jittery over the implications of Trump's "Big Beautiful Bill" for federal deficits and debt. The debt is up to a record $36.2 trillion, with $28.6 trillion in marketable securities held by the public (chart).

The Congressional Budget Office estimates the bill would add approximately $2.3 trillion to the national debt over the next decade (2025–2034). The Committee for a Responsible Federal Budget (CRFB) projects an increase of $3.3 trillion to $5.3 trillion over the same period, depending on whether temporary tax cuts (e.g., no taxes on tips and overtime) are extended beyond their initial four-year duration. If extended for a full decade, the cost could reach $5.7 trillion or more.

So is a US government debt crisis imminent? Will the Bond Vigilantes push the 10-year Treasury yield well above 5.00% in coming weeks? It's possible, especially since tariffs already implemented by Trump are likely to boost inflation in coming months. However, the anticipated rebound in inflation should be moderated by weak energy prices. Indeed, the Cleveland Fed's Inflation Nowcasting model is tracking May's CPI headline and core inflation rates at just 0.12% m/m and 0.23% m/m.

The US Treasury could keep a lid on the long end of the yield curve by announcing that more of the deficit will be financed with Treasury bills rather than Treasury notes and bonds, as former Treasury Secretary Janet Yellen did on November 1, 2023 (chart). We've referred to this as “Yield Curve Control by the Treasury (YCC-T).” If a full-blown debt crisis occurs, the Fed could revive Quantitative Easing (QE) to provide liquidity to the bond market. 

A debt crisis need not be a calamity if it forces Washington to put US fiscal policy on a credible sustainable course. If that were to happen, a debt crisis would provide another good opportunity to buy stocks. Fasten your seat belts.

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