Democrats and Republicans have plenty at stake in the upcoming midterm elections. But it’s already looking like a no-win situation for the U.S. bond market.
If Democrats take the House, it raises the odds that congressional leaders will propose an infrastructure-spending bill similar in scope to President Donald Trump’s original trillion-dollar proposal. And if the GOP defies expectations and holds on in Congress, tax cut 2.0 becomes more likely. In either case, the result will be debt, debt and more debt.
That’d be on top of what is already a grim fiscal situation. A deluge of debt supply is set to inundate the $15.3 trillion Treasury market, just as borrowing costs rise. Not only is the U.S. budget deficit primed to swell to roughly $1 trillion by fiscal 2019 and past that in subsequent years, but the interest owed by the government is also forecast to triple in the coming decade to nearly a trillion dollars a year, according to the Congressional Budget Office.
“The current debt trajectory is already quite onerous,” said Subadra Rajappa, an interest-rate strategist at Societe Generale. “If you keep increasing supply and auction sizes, there is a point where the bond market is going to say, ‘Thanks, but no thanks.’”
The consequences could be far-ranging. With Treasury Secretary Steven Mnuchin set to double new issuance this year and the Federal Reserve scaling back its debt purchases, any dropoff in investor demand for the burgeoning supply of U.S. Treasuries could mean tens of billions of dollars in additional interest -- all of which taxpayers would ultimately have to pay.
Signs of pushback have already started to appear. At varying times this year, a strong economy, a hawkish Federal Reserve and worries about the deficit and inflation have all conspired to sour investors on Treasuries.
In recent weeks, the yearlong selloff in Treasuries has accelerated, pushing yields -- the effective cost for the U.S. government to borrow money -- to multiyear highs. Last week, the 10-year note soared above 3.2 percent for the first time since 2011. Demand at a recent Treasury debt auction (where the U.S. actually borrows the money it needs) also fell to a decade low.
Of course, it’s perfectly reasonable to think that Democrats will have zero appetite to do Trump any political favors before the next presidential election cycle, like passing an ambitious infrastructure spending bill. And Republicans may suddenly re-discover that they’re supposed to be the party of fiscal discipline and hold the line on more tax giveaways.
Debt Burden
But even if nothing changes on Capitol Hill, America’s finances are far from secure.
Trump’s once-in-a-generation tax cut, along with increased spending for Social Security and Medicare as the baby boomer generation retires, are already set to boost the public debt burden by $10 trillion over the next decade, CBO estimates show. By that time, net interest costs will reach $915 billion. (That’s up from a record $523 billion in interest paid in the year ended Sept. 30.)