U.S. Federal Reserve Chair Jerome Powell will hold his semi-annual testimony to Congress this week. No doubt, we will hear from the White House about how much they should be cutting rates.
We are going to see the debt ceiling lifted in July shortly after the Big Beautiful Bill is written into law. The U.S. Treasury will need to rebuild the Treasury General Account and how that gets funded will matter for risk markets. Since the Federal Open Market Committee (FOMC) started cutting rates, the long end has seen rates go higher.
The long end of the curve is beginning to worry about inflation. We expect Powell will spend some time educating Congress on debt finance 101 this week, though he historically does not comment on matters of the Treasury.
At the end of May, the average weighted cost of the U.S. debt was 3.36 per cent on outstanding debt of US$36.24T. With the debt refinancing calendar in the next two years, that rate is likely to move up above 3.5 per cent and be closer to $40T.
That is a cost to the U.S. taxpayer of about $1.3T. The U.S. is on a fiscally unstable path and most of Congress does not care.
The fiscally conservative side of Congress wants new revenue to pay for it or expense cuts and the Donald Trump administration sees tariffs as one of those sources of revenues.
This is the dilemma that the FOMC faces as the tariffs are widely believed to be inflationary with dynamic CBO scoring or not. In past cycles, the absolute size of the debt and annual costs were manageable. They are now a significant drag.
Average interest rates on U.S. Treasury securities
Bottom line is that yields can only come down if inflation comes down and until there is more certainty there, the FOMC is likely on hold.
The catalyst for rate cuts is a weakening economy and no one really wants that in the Republican Congress heading into mid-terms. To be clear, AI and technology remain disinflationary influences.
It’s also generally thought that an aging society is disinflationary. That backdrop is likely to continue, so while the current inflationary pressures may be transitory, the deficit and debt problem is not and that should keep a more permanent term premium in the bond market.
We are currently bullish on long U.S. Treasuries, but it’s because we think we see the labour market weaking and a harder landing coming. Investors should not expect yields in the U.S. to go back to the post GFC and pre-COVID 19 levels.
Higher rates are likely here for longer. In Canada, we have a structurally weaker economy and until we have better policies to drive growth in Canada, rates are likely to be lower here.
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