Analysts commonly use the ten-year treasury rate to represent a proxy for the ‘risk-free asset’ in pricing models. Typically, we think of risk-free in terms of credit risk, i.e., the U.S. government does not default; therefore, your money is safe in treasuries. This is why we tend to call treasuries ‘risk-free.’ Even when you factor out spread risk (yields between two credit classes widening) and default risk, treasuries are not immune to purchasing power risk and interest rate risk. When yields go up, prices fall, and this is exacerbated by duration (think years to maturity).
Yields are much higher now than they have been in most of the last ten years. The yield on the 10-year treasury as I write this is hovering between 4.4 and 4.5. June 1, 2015, it was 2.19 and was only briefly above 3% until 2022.[1] There are positives and negatives to this. The positives are that a 60-40 portfolio may be more robust (compared to 2022 when yields were lower) when a drawdown in the market could be mitigated by a flight to safety or rate cuts from the Fed. Also, higher yields mean we can earn more with savings. That said, higher borrowing costs for the U.S. and by extension U.S. corporations, can slow growth.
Treasury yields started to rise rapidly in 2022. This was the Federal Reserve’s answer to the inflation that followed the pandemic era spending. The Fed has yet to reduce rates to their long-run target (about 3 percent based on March 2025 projections)[2] due to the persistence of inflation. These higher rates combined with quantitative tightening (reducing its balance sheet and buying less treasuries), have been the Fed’s attempts at cooling down inflationary pressure.
The United States has a lot of debt, nearing thirty-seven trillion as I write this.[3] This is not a controversial statement nor is it new information. The economic theory to this point is that if growth (g) is greater than borrowing costs (r), then borrowing is a prudent economic decision. With borrowing costs increasing and the projection of future growth stagnating or decreasing, the g > r rationale is starting to look shaky. One would think that pandemic era spending would be a “break glass in case of emergency” situation and that the government would go back to spending at pre-pandemic levels plus some small percent to account for growth (or inflation) since 2020. However, we are still well above what would be expected if you rewound back to 2019. The potential of extending the tax cuts from 2017 can add even more on to our deficit. It turns out that, “We’re going to raise taxes and cut spending” is not the best political platform.
Tariffs also rattled the debt markets. Tariffs create inflationary pressure, which could cause the Fed to keep rates higher. The haphazard nature of our new tariff policy could deter business investment and disrupt supply chains and slow down the economy. Additionally, reduced global trade can decrease demand or dollars and Treasuries when other nations do not need as many U.S. denominated assets for trading purposes. Like a game of chess, tariffs are complex, and trade negotiations are ongoing. Right now, it is difficult to see if the U.S. trade policy is in the process of making a brilliant queen sacrifice or a significant blunder. Time will tell.
There is greater potential than normal for reduced demand for U.S. government debt because of geopolitical tensions, quantitative tightening, and eroding confidence on fiscal stability. At the same time, we are continuing to spend, increasing supply. This is a potentially bad outcome for U.S. borrowers. We can be looking at higher mortgage rates, lower growth, and lower corporate investment.
Despite many challenges, opportunities for positive change exist. The projected interest payments, and the fact that sovereign debt is rising globally could be a catalyst for a global discussion on how to address fiscal stability. Despite the partisan bickering around the calls for increased government efficiency and accountability, there is a real appetite for increased scrutiny on government waste. Also, there could be the possibility of a significant tax reform to address the need for additional revenue that could simplify the tax code and increase fairness (acknowledging that ‘fairness’ in taxation is subjective). D.C. may be the land of brilliant political tacticians, but we need strategic thinking to maintain the global U.S. influence.
[1] https://fred.stlouisfed.org/series/DGS10
