Weak demand at last week's auction of 20-year US Treasuries suggests that investors fear the US fiscal trajectory is becoming unsustainable. For context, the US budget deficit has reached $1.9 trillion over the past year, or 6.4% of GDP. Donald Trump's proposed tax cuts, which are expected to add another $3 trillion to the deficit over the next decade, are not expected to improve things any time soon.
Yes, tariff revenues are rising: as of May 22, $16.5 billion in tariffs had been collected, up from $11.7 billion in April and about $6.1 billion in February-March, and could generate about $180 billion in revenues over the next year. Sounds like a success, but the problem is that, with debt service costs rising due to rising Treasury yields, most of that additional revenue could be absorbed by interest payments.
Strained relations with major trading partners also weigh on the demand for debt from the U.S. government. For example, Japanese institutions, instead of increasing their holdings of U.S. bonds, sold $119.3 billion in Treasuries in just one quarter. For obvious reasons, China is also unwilling to increase its exposure to U.S. debt. Even the Philippine central bank has signaled that it may reduce its holdings of US Treasuries.
Given the circumstances, it is not surprising that investors are demanding a higher risk premium. So, while the recent move in the S&P 500 might suggest that markets have discounted the bad news, the bond market tells a different story. Despite some progress in the tariff negotiations, investors are clearly not buying it. Despite what the president's tweets claim, there has been no real, concrete improvement.
As for where the money flows from US treasuries, gold (XAUUSD) is the biggest winner. Some also point to Bitcoin's rise to record highs as part of this shift. However, while central banks are unlikely to add such a speculative asset to their reserves, the current U.S. debt situation creates a favorable backdrop for Bitcoin prices and other cryptocurrencies to thrive as alternatives to traditional money and assets.
So could rising yields prompt the Fed to cut rates soon?
Like many of his colleagues, Minneapolis Fed President Neel Kashkari stressed that future decisions will depend on incoming data and the direction of trade negotiations, suggesting that there is no rush yet to change policy. Meanwhile, Atlanta Fed President Raphael Bostic noted that many U.S. companies may have run out of room to delay price hikes or personnel changes in response to rising tariffs.
If the latter is the case, the US economy could be approaching a new round of inflation. In this context, it is not surprising that Jerome Powell opposes Trump's calls for an immediate rate cut. Most likely, the minutes of the Fed's last meeting, released this Wednesday, will also show similar rhetoric. As for market expectations, CME futures suggest that a rate cut before September is unlikely, at least for now.