Rising U.S. Debt: Impacts on Economy and Global Stability

Treasury yields have spiked recently, reflecting mounting fears that investor demand for U.S. debt is waning just as supply increases significantly. A budget bill currently in Congress is anticipated to add trillions to the federal deficit, exacerbating these concerns. However, the fallout from rising U.S. debt is not confined to the American economy alone; recent insights from the Institute of International Finance (IIF) suggest that it could trigger a contagion across global markets.

The Implications of Rising U.S. Debt

It is imperative to understand that the repercussions of soaring U.S. debt extend beyond national borders. As borrowing costs in various countries often respond to movements in U.S. Treasury yields, volatility in U.S. debt instruments can create ripples in foreign bond markets. According to a report by IIF, published on May 22, the rising levels of U.S. debt pose risks not only to domestic fiscal stability but also to the global financial architecture.

“The implications of rising U.S. debt levels are not limited to the domestic economy; they are also likely to trigger significant contagion and spillover effects across global bond markets,” IIF economists noted.

Recent Developments in U.S. Debt Markets

The U.S. has found itself in a precarious fiscal situation, particularly with a Republican-led budget bill in Congress that could add trillions to the national budget deficit over the next decade. The resulting increase in Treasury supply has jolted yields, prompting concerns about the government’s ability to finance such significant deficits. Recent events underscored these fears: a weak demand at a recent 20-year bond auction highlighted potential issues in attracting sufficient investor interest for new bond issuances.

Deutsche Bank has warned of a potential buyer’s strike among foreign investors, who may be increasingly reluctant to finance ongoing U.S. fiscal and trade deficits. This skepticism regarding demand for U.S. Treasuries, combined with rising yields, indicates a troubling trend that could have far-reaching implications.

Global Contagion: How Sovereign Yields are Interlinked

IIF pointed out a notable trend: sovereign yields across major economies, including the U.S., the U.K., Germany, and France, tend to move in unison. This correlation exists due to the deep financial interconnections among these economies, facilitated through extensive trade relationships and capital markets. These linkages suggest that volatility in the U.S. Treasury market could transmit to other jurisdictions, though the extent of the impact may vary depending on local economic factors.

• Yield Sensitivity: The IIF report noted that yield sensitivity is less prominent in Japan and several emerging markets, yet there have been recent instances highlighting interconnections. For example, a weak auction of 40-year Japanese government bonds caused a spike in Japanese Government Bond (JGB) yields, subsequently influencing U.S. Treasury rates.
• Emerging Markets Concerns: As the U.S. and Euro Area constitute over 60% of global cross-border debt portfolios, emerging markets (EMs) feel the pressure from rising U.S. debt levels, particularly given their shrinking access to international capital.

A Closer Look at Emerging Markets

The shifting dynamics of investments in U.S. debt could have profound implications for EMs. Relative to developed nations, which can rely on significant global investment pools, emerging markets only comprise about 7% of total cross-border debt holdings. The IIF report underscores that many EM nations account for insignificant percentages, making them vulnerable to shifts in investor sentiment towards U.S. Treasuries.

Furthermore, experts assert that as U.S. yields rise, EMs might face higher borrowing costs domestically, compelling investors to reconsider allocations. As George Saravelos, head of FX research at Deutsche Bank, recently noted, a rising yield environment generates attractive alternative investment avenues, thereby promoting further divestment from U.S. assets.

Conclusion

The implications of America’s soaring debt levels extend far beyond its borders, emphasizing the interconnectedness of global financial systems. Investors, central banks, and policymakers worldwide must remain cognizant of how these dynamics play out. While the vastness and liquidity of the Treasury market will continue to attract buyers and sellers, the growing sensitivity among EMs and the risk of contagion should not be understated amid a changing fiscal landscape.

Source: fortune