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As Scott Bessent, Trump’s nominee for Treasury secretary, endured his first congressional hearing on Thursday, he was grilled about America’s economic challenges.
Even before it started, there was evidence of that: On Wednesday, the Mortgage Bankers Association reported that the 30-year mortgage rate jumped above 7 percent, after rising 1 percentage point in the 10-year Treasury yields since last fall.
That’s not particularly criminal by the standards of financial history. Since 1971 the average mortgage rate was 7.73 percent — and before 1990, rates were generally over 10 percent. But the problem is that American voters have grown accustomed to 3 percent rates over the past decade. Indeed, the real estate industry has become so dependent on cheap money that insiders told me that if 10-year yields rise to 5 percent any time soon — from the current level of 4.65 percent — they expect a series of defaults.
And what’s particularly significant — and unwelcome — about this development is that it happened even though the Federal Reserve has been easing policy significantly since last fall. Such a deviation is highly unusual – and implies that traders are blowing the Fed’s nose.
Why? If you’re an optimist, you might blame the strong US growth outlook for rising rates. A less optimistic explanation is that investors are ready for rising prices. During the stock market he gathered himself this week on better-than-expected inflation data, that could change if President-elect Donald Trump follows through on his threats to impose trade tariffs and mass deportations.
Other possible explanationsuggests the Center for Economic Policy Research, is that central banks outside the US are secretly reducing their Treasury purchases. And one factor that could boost long-term returns is that Bessent has (rightly) criticized Janet Yellenits predecessor, to expand the issuance of short-term debt. This implies that it hopes to sell more long-term debt.
However, the most contentious – and consequential – issue is the US fiscal outlook. Right-wingers have been warning for years that this is on an unsustainable path: given current trends, debt to GDP ratio it is projected to move from 100 percent to 200 percent in a decade — and the deficit is now over 6 percent of GDP.
This prompted the influential “Tree Rings” newsletter by Luke Gromen to warn that if the 10-year yield rises above the nominal growth rate, “it is mathematically certain that it will quickly start a debt death spiral. . . unless one or both US rates decline rapidly or US nominal growth accelerates further”. He believes it has already happened.
More significantly, this week Ray Dalio, founder of hedge fund Bridgewater, announced the first part his analysis of historical debt crises. He said he was “deeply concerned” that America was “going to collapse” and warned that the decades-long debt cycle could soon explode.
Fortunately, Dalio believes that this ugly scenario could still be avoided if radical reforms make the debt burden more sustainable. This could include cutting interest rates to 1 percent, allowing inflation to rise to 4.5 percent, increasing tax revenues by 11 percent, cutting discretionary spending by 47 percent, or some combination.
But implementing such a holistic mix of policies will be difficult, he added. And that has two implications. In macroeconomic terms, this limits Bessent’s room for maneuver; he admitted on Thursday that the country is now “hard pressed” for fiscal firepower. And in financial terms, there is a noticeable — and growing — risk of market turmoil if investors buy into Dalio’s bleak predictions.
I’m told that some of Trump’s supporters, such as Howard Lutnick, the head of Cantor Fitzgerald and a nominee for Commerce Secretary, insist that such market pressures can be contained. After all, global financial institutions must buy and hold government bonds – almost regardless of price – to meet regulatory rules. And foreign investor demand for US debt continues to appear sky highespecially in places like Japan.
But, as I am recorded rather, an increasing portion of that foreign demand now comes from potentially volatile hedge funds. And during a recent trip to Asia, senior financiers muttered that they are secretly looking for ways to protect their huge exposure to Treasuries — even as they gobble them up. The same thing is happening in Europe.
Fortunately, Bessent seems to understand this dynamic well. Indeed, he told Congress that the reason he left his “quiet life” as a hedge fund manager to serve at the Treasury Department was that he felt a duty to tackle these fiscal pressures — and thus avoid Dali’s doom loop.
But whether he has the political clout – or brains – to do so is anyone’s guess. He must be in a race against time. Therefore, investors are better off continuing to watch those government bond yields.
After all, one thing Trump doesn’t want in front of him is a complete market crash, let alone a Magi revolt over rising mortgage rates. If anything will impose discipline on his administration, it might just be those bond rates; indeed, it is probably the only factor that will.
