Why are interest rates so high?
The ten-year Treasury yield recently rose above 5 percent. Rising rates push borrowing costs and mortgage rates higher. Why is this happening?
Reason 1: Government Debt
Actually, there are 40 trillion reasons. That’s because U.S. debt has topped $40 trillion. Our country spends more money servicing this debt than we do on our military. In fact, these interest payments carry the same price tag as paying each U.S. citizen about $5,000 annually.
The annual deficit is about 6 percent of GDP, a level typically seen only during wars and recessions. Compare that to the years 2002 to 2007, when the deficit averaged just 2.3 percent of GDP. If the deficit is this high during economic growth, what will happen when a recession or economic shock hits?
Rising debt means higher interest payments. Therefore, if U.S. debt were lower, interest rates and mortgage rates would be lower too. Most don’t see the connection between government debt and the housing affordability crisis, however. Politicians fail to act because the public has no appetite for paying higher taxes or cutting programs like Social Security and Medicare.
The Trump administration projects the deficit will rise by 16 percent this fiscal year. Add in heavy borrowing from the largest technology companies to fund the massive AI build-out, and it’s easy to see why rates face upward pressure.
Reason 2: Inflationary Pressures
Inflation has remained above the Fed’s two percent target since 2022, and it’s trending in the wrong direction. Until 2020 inflation wasn’t a problem. Since then, a long list of inflationary pressures has emerged. These include supply chain disruptions related to Covid-19 and the AI boom, Russia’s invasion of Ukraine, increasing tariffs and protectionism, and the decision to invade Iran.
Some economists argue these are one-off events and that inflation will eventually fall. But are they? The Iran conflict, which has cost $38 billion through July, continues to keep gasoline prices elevated. A possible response would be to suspend the federal gasoline tax, but that would add $3.5 billion a month to the U.S. debt.
What does this mean for investments? Rising yields lower bond prices, so the bond market may not serve as a safe hedge when stocks fall. Eventually, though, these yields will become attractive to investors. The market will figure out when that turning point occurs.
David Vomund is an Incline Village-based fee-only money manager. Information is found at www.VomundInvestments.com or by calling 775-832-8555. Clients hold the positions mentioned in this article. Past performance does not guarantee future results. Consult your financial advisor before purchasing any security.
