After Moody’s Warning, Federal Officials Continue To Ignore Fiscal Reality
That’s contrary to the, let’s say, traditional view of how government-issued bonds work.
A bond’s yield—that is, the return an investor expects to be paid at the end of the bond’s term—is the result of buyers pricing their risk into the purchase. Treasury bonds have historically been some of the most reliable investments out there and, as a result, have typically carried low yields. In other words: Because you can be very confident that the U.S. government will pay you back at the end of the term, you know that your investment is safe, but you also don’t stand to make much on the risk.
And while U.S. Treasury bonds remain very safe investments, the traditional view would say that the recent uptick in yields means investors are pricing just a bit more risk into those purchases. For example, the yield on 10-year Treasury bonds—a key benchmark that helps determine the rates of mortgages, student loans, and more—hit a 16-year-high of 5 percent late in October, though it has fallen a bit since then.
In short: Buyers will demand higher yields in order to make riskier investments. That’s why the 10-year U.S. Treasury bond yield peaked at 5 percent, while a 10-year Russian bond comes with a yield north of 12 percent. (As an aside, there’s something cool and quite libertarian about all this: Governments must answer to the market. It costs the Russian government more to borrow funds simply because investors are less confident that Russia won’t stiff them a decade from now.)
So what could be causing investors to price higher risk into U.S. Treasury bonds right now? Yellen says it is the result of a strong economy and the sense that interest rates will remain higher for a longer-than-expected period of time. But that seems to ignore the 300-pound gorilla in the room—or, rather, the $33 trillion mountain of IOUs threatening to bury the Treasury building and the U.S. economy.
It seems more likely that investors are looking at the trajectory of federal budget deficits and the national debt and that they are now hedging their bets, ever so slightly, to account for the possibility of a first-ever federal defaul
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