Scott Bessent, Trump's nominee for Treasury secretary, appeared in his first congressional hearing on Thursday, where he was grilled about the U.S. economic challenges.
Before he started, however, the evidence was already emerging: On Wednesday, the Mortgage Bankers Association reported that the 10-year Treasury yield has risen 1 percentage point since last fall and the 30-year mortgage rate has jumped to 7 % above.
By the standards of financial history, this is not particularly punitive. Since 1971, the average mortgage rate has been 7.73%, and before 1990, rates generally exceeded 10%. But the problem is that American voters have become accustomed to 3% interest rates over the past decade. In fact, the housing industry has become so obsessed with cheap money that insiders tell me that if the 10-year Treasury yield rises to 5% for any period of time - from its current level of 4.65% - they expect it to There was a series of defaults.
What's particularly noteworthy and unwelcome about this development is that it's happening despite the fact that the Fed has been easing policy quite significantly since last fall. The divergence is highly unusual and means traders are making a lot of noise about the Fed.
Why? If you're an optimist, you might blame rising interest rates on America's strong growth prospects. A less optimistic explanation is that investors are ready for higher prices. While stocks rose this week on better-than-expected inflation data, that could change if President-elect Donald Trump follows through on his threats to impose trade tariffs and mass deportations.
The Center for Economic Policy Research believes that another possible explanation is that non-U.S. central banks are secretly reducing their Treasury bond purchases. One factor that could push longer-term yields higher is Bessant's (rightly) criticism of his predecessor, Janet Yellen, for expanding short-term debt issuance. That means he wants to sell more long-term debt.
The most contentious and important issue, however, is America's fiscal future. Right-wing pundits have been warning for years that this is an unsustainable path: On current trends, the debt-to-GDP ratio is expected to rise from 100% to 200% within a decade, while the deficit currently stands at more than 6% of GDP percentage.
This prompted Luke Gromen's influential Tree Ring newsletter to warn that if 10-year Treasury yields rose above nominal growth, it would "mathematically be a surefire trigger for debt." Death spiral…”. . . Unless one or both of the U.S. countries cut interest rates quickly, or U.S. nominal growth accelerates," he thinks that may have already happened.
More notably, this week Bridgewater hedge fund founder Ray Dalio published the first part of his analysis of historical debt crises. He said he was "deeply concerned" that the United States was going "insolvent" and warned that the decades-long debt cycle could soon collapse.
Thankfully, Dalio believes this ugly situation can still be avoided if radical reforms make the debt burden more sustainable. This could include cutting interest rates to 1%, letting inflation rise to 4.5%, increasing tax revenue by 11%, cutting discretionary spending by 47%, or some combination.
But he added that implementing such a holistic policy mix would be difficult. This has two meanings. From a macroeconomic perspective, it limits Bessant's room for maneuver; he acknowledged on Thursday that the country's fiscal firepower is now "stretched." From a financial perspective, if investors accept Dalio's pessimistic forecast, the risk of market turmoil will be significant and rising.
I'm told that some Trump supporters, such as Howard Lutnick, head of Cantor Fitzgerald and Commerce Secretary nominee, insist that such market pressures can be contained. After all, global financial institutions need to buy and own U.S. Treasuries — with little regard to price — to satisfy regulatory rules. Foreign investor demand for U.S. debt appears to remain high, especially in places like Japan.
But, as I noted before, a large portion of this foreign demand now comes from potentially frivolous hedge funds. On a recent trip to Asia, senior financiers muttered that they were secretly looking for ways to hedge their exposure to huge U.S. Treasuries — even as they gobbled them up. The same thing happened in Europe.
Thankfully, Bessant seems to understand these dynamics. In fact, he told Congress that he left his "quiet life" as a hedge fund manager for a job at the Treasury Department because he felt a responsibility to address these financial pressures and avoid a Dalio-like doom spiral.
But whether he has the political power — or wisdom — to do that is anyone’s guess. He is undoubtedly racing against time. So investors would be wise to keep watching U.S. Treasury yields.
After all, the one thing Trump doesn’t want is a total market meltdown, let alone a MAGA revolt against soaring mortgage rates. If anything will impose discipline on his administration, it might be these bond rates. In fact, this may be the only factor that makes this happen.
gillian.tett@ft.com