Rising US bond yields: what happened and what are the broader implications

The US bond market has been in focus for the past couple of months after the US fiscal situation came under pressure due to a host of factors like high inflation, mounting government debt, impending recession and more. Recently, the global ratings agency, Moody’s, downgraded the US government debt from AAA to AA1, which raised more concerns about the worsening fiscal situation in the US. Following the developments, the bond jumped over 1%, the US 30Y yields rose past 5%, and the benchmark 10Y yield jumped to 4.6%. Rising yields are inversely related to equity markets as they attract flows from riskier assets to safer bets.

First-ever ratings downgrade by Moody's

Moody’, the global credit rating agency, downgraded the government debt from AAA to AA1 with a stable outlook. The report cited the US's ballooning government could reach to 134% of GDP in 2030 from 98% in 2024. Further, the fiscal policies would also increase the deficit to 9% from 6%. Investors worry that Trump’s fiscal policies would increase the uncertainty and raise the prospects of recession. The downgrade triggered the rise in bond yields, sparking fresh worry for the government.

Lukewarm response to bond auction

The 20Y bond auction on Wednesday saw very soft demand from investors, adding to concerns about the US debt burden. Poor auction demand highlights lower confidence in the US debt securities and adds pressure to equity markets on losing confidence in the US economy. It also undermines other macroeconomic indicators, like improving inflationary pressures and strengthening labour data.

Equity markets see spillover effects

The US equity markets fell more than 2% on Wednesday after softer demand for US debt securities raised concerns about US economic prospects. The Dow Jones, S&P 500 and NASDAQ fell over 2%. Additionally, the newly passed tax and spending bill could add $4 trillion to the national debt of $36 trillion, adding more impetus to the bond yields. Investors remain cautious about rising fiscal instability in the US.

Broader implications

Rising bond yields usually do not bode well for economic growth as they raise the cost of debt in the economy. Higher cost of debt would lower the spending capacity of consumers and deter the investment sentiment. Furthermore, rising yields could also increase the odds of recession. Higher yields can be controlled by reducing interest rates, but the Federal Reserve is cautious about controlling inflation, holding it back from cutting the interest rates.

Largely, the US debt situation is a result of a consistent and prolonged lower interest rates and uncontrolled government spending. According to the US economy would have taken the bitter pill of recession sooner or later to avoid it from bigger catastrophe like the great depression.