Inflation and deficit do not overshadow the appeal of US bonds

Looking forward and past

What happens when the cost of borrowing this rock bottom rises dramatically? There could be a crisis of confidence in Fed policy, a geopolitical crisis or a sharp increase in the Fed’s key interest rates in an attempt to reduce inflation. In a more conceivable scenario, some believe that if inflation remains near current levels in the second half of the year, bond buyers may lose patience and reduce purchases until yields are more in line with prices. increase.

Marc Goldwein, senior policy director at the Federally Responsible Budget Committee, said paying higher interest on debt would force budget cuts. Mr. Goldwein’s Foundation, which promotes balanced budgeting, estimates that even under last year’s low rates, the federal government will spend more than $300 billion on interest payments – more than it spends individually on food stamps, housing, disability insurance, science, education or technology.

Last month, Brian Riedl, a senior fellow at the right-wing Manhattan Institute, published an article titled “How higher interest rates could push Washington toward a federal debt crisis. ” It concluded that “debt was forecast to rise to unsustainable levels even before any new proposals were enacted.”

Reidl writes that the offsetting demographic and global trends that have pushed rates down are an “accidental and possibly temporary” subsidy to federal legislators. Assuming those trends are long-term, he said, would be like being a complacent team that “has been trying to improve its win-lose record for many seasons – despite a dwindling defence.” quickly – because their offense continues to improve enough to barely outpace its rivals. ”

But at least one historical trend suggests that interest rates will remain stable: the overall decline in real interest rates around the world dating back six centuries.

An article published in 2020 by the Bank of England and written by Paul Schmelzing, a postdoctoral research associate at the Yale School of Management, shows that as political and financial systems have globalized , innovate and mature, the safest borrowers – the strong governments – that will default have steadily declined. According to his paper, a possible ramification is that “regardless of specific monetary and fiscal responses, the real rate may soon enter permanent negative territory”, yielding less than the inflation rate.

An old rule that still holds true in the markets is that high-risk bets reward investors with higher yields, but bring high borrowing costs to borrowers. In turn, low-risk investments come with cheap borrowing costs. If the Fed and other central banks consistently demonstrate that they can stabilize (or bail out) the most systemically important governments, investment risk will be reduced – and possibly even more so. plenty of time to borrow for years to come.