Concerns Over US Fiscal Management Grow as Bond Yields Rise Amid Inflation Decline

• Concerns over rising bond yields amidst declining inflation highlight critical issues in US fiscal management and tariff policies.

• The combination of escalating government spending and persistent fiscal deficits exacerbates investor uncertainty, signaling potential economic instability.

• Economist Steve Hanke emphasizes the need for constitutional reform to ensure fiscal discipline in the face of chronic spending issues.

This article delves into the complexities driving US bond yields higher despite declining inflation, highlighting insights from economist Steve Hanke.

The Dynamics Behind Rising Bond Yields

The recent uptick in government bond yields, particularly amidst a backdrop of decreasing inflation rates, has sparked significant interest among investors and economists alike. The bond markets are traditionally viewed as safe havens, but fluctuations in yields suggest deeper, underlying issues within the US economy.

Statistics reveal a stark trajectory: the US 10-Year Treasury Yield has surged from 4.17% to 4.43% since late April. This spike underscores a market increasingly skeptical of the government’s economic stewardship.

US 10-Year Treasury Bond Note Yield. Source: Trading Economics.

Despite an easing inflation rate shown in recent CPI Index data, rising bond yields reflect heightened investor anxiety about **geopolitical tensions** and potential economic slowdowns. Hanke asserts this paradox results from factors such as sovereign credit risk and dwindling confidence in fiscal management.

The Role of ‘Bond Vigilantes’

Historically, well-informed investors—dubbed “bond vigilantes”—have responded to unsustainable fiscal policies by offloading bonds, an action capable of inflating borrowing costs. This phenomenon resurfaces as concern mounts over the US’s massive debt, peaking at $36 trillion, alongside a staggering budget deficit of $1.8 trillion.

Federal Deficit Trends Over Time. Source: US Treasury.

According to Hanke, significant disappointment emerged from a recent Treasury auction, which saw minimal interest. “There was virtually no central bank or primary dealer buying,” he remarked, signaling widespread trepidation about US fiscal practices.

The Implications of a Shrinking Money Supply

While rising bond yields often imply a tightening financial environment, Hanke cautions against interpreting this development in isolation. A deeper concern lies in the **decaying money supply**, as commercial banks, crucial for economic liquidity, have been curtailing lending.

“Presently, commercial bank credit growth stands at an anemic 2.3% annually, indicating a significant economic slowdown,” Hanke noted. This contraction curtails consumer spending and business investment, compounding the challenges linked to government spending.

Assessing the Dollar’s Future Viability

Volatility in the US Treasury market and attempts by G7 nations to reduce reliance on the dollar have prompted discussions regarding the future of US currency dominance. However, Hanke describes these fears as exaggerated. He emphasizes that historically, only 14 international currencies have maintained dominance since the 7th century BC, affirming the dollar’s enduring status.

Hanke argues that attention needs to pivot away from fluctuating yields and towards ensuring effective fiscal policies, which has largely fallen to Congress, historically slow to act.

Addressing the Root Cause of Fiscal Imbalance

The United States has grappled with government spending driven by various factors, including entitlement programs and military expenditures. Hanke advocates for a **dedicated Congressional committee** to explore spending cuts and tax reforms necessary to manage the national debt sustainably.

“Congress must construct a Fiscal Sustainability Commission to propose necessary reforms,” Hanke advises, spotlighting the urgent need for structured fiscal oversight.

Proposing a Constitutional Solution

To effectively manage ongoing spending issues, Hanke recommends a Constitutional Amendment that would enforce fundamental fiscal discipline on Congress. This proposal reflects the need for a structured approach to prevent irresponsible budget practices.

“Only a Constitutional Amendment can instill the discipline necessary to curb irresponsible spending,” he states. The course of the US economy now hinges on whether policymakers will embrace decisive actions or allow uncertainty to prevail.

Steve H. Hanke, renowned for his expertise, continues to advocate for meaningful reforms. His latest work, co-authored with Matt Sekerke, delves into the essential updates needed within the financial system.