During a live television briefing last month on the White House lawn, President Donald Trump boasted that his administration had “accomplished an economic turnaround of historic proportions.”
That’s debatable. But whatever the case, the bill for his economic policies is starting to come due.
Trump’s $1.5 trillion of tax cuts in December, designed to stimulate growth, have decimated government revenue, ballooning the federal budget deficit and forcing Treasury Department officials to cover the gap by borrowing money in unprecedented amounts.
This week, the Treasury sold a record $26 billion of 10-year notes along with $18 billion of 30-year bonds, also a record, as part of a quarterly government financing package that’s projected to be the biggest since the recession a decade ago. Some Wall Street analysts speculate that the growing supply of Treasury bonds hitting the market could overwhelm demand from investors, driving down prices for the securities.
The yield on 10-year U.S. Treasury notes, which moves in the opposite direction of their price, has more than doubled since mid-2016 to about 2.93% currently. That’s already close to a seven-year high, and Jamie Dimon, CEO of JPMorgan Chase & Co. (JPM) , the biggest U.S. bank, warned recently that the government’s increasing bond issuance means investors should prepare for a 5% yield, a level not seen since 2007.
This week’s bond sales had little effect on the market; the yield on 10-year notes actually fell by 0.2 percentage point over the course of the week — a sign that demand is sufficient to absorb the increased supply of the bonds.
Larry Milstein, head of government and agency trading at the brokerage firm R.W. Pressprich in New York, said that many big investors still appear to find U.S. Treasury notes attractive, partly because yields on government bonds from other big markets, such as Europe and Japan, are so low. There’s also been robust demand for the securities from pension funds and insurance companies.
“Considering the budget deficits we’re facing and the expectation that we’re going to continue to see big deficits, the market absorbed the supply pretty easily,” Milstein said in a phone interview.
According to a Treasury Department report last month, the government plans to issue some $329 billion in net marketable debt from July through September, more than the $273 billion it estimated in April.
When combined with a projected $440 billion of debt to be sold from October through December, the total for the second half of 2018 would be the most for that period since 2008, when the financial crisis plunged the U.S. economy into recession and caused the federal budget deficit to swell, according to Bloomberg News.
Trump and Treasury Secretary Steven Mnuchin have said that the tax cuts will pay for themselves – by stimulating economic growth to the point where the government becomes flush with new revenue.
But the Congressional Budget Office projects that the federal deficit will swell by 21% this year to $804 billion and continue growing after that. The shortfall is expected to eclipse $1 trillion in 2020 and remain above that threshold at least through 2028.
Ethan Harris, an economist with Bank of America Corp. (BAC) , wrote last week in a report that the deficit would hit 4.7% of gross domestic product in 2019, up from 3.2% in 2016, before Trump took office.
“This would be the largest deficit for an economy at full employment since World War II,” Harris wrote.
So how high could Treasury yields go?
Dec Mullarkey, a managing director at Sun Life Investment Management, which oversees about $50 billion, says a good rule of thumb is to add the expected inflation rate, currently about 2%, to a sustainable long term economic growth rate of 2%. On that basis, 10-year yields settling around 4% over the next few years seems reasonable, Mullarkey wrote in an e-mail.
It all depends on how the economy actually performs in response to Trump’s tax cuts. If his oft-touted projections for a surge in growth and new jobs fails to pan out, taxpayers could be looking at big deficits for years to come.
They’ll also have ample opportunities to buy more Treasury bonds, with more record-breaking sales likely. Over the coming decade, the amount of debt held by the public could roughly double to about $29 trillion, based on CBO estimates. And that figure doesn’t even include debt owed by the Treasury to other U.S. government agencies, another big chunk of liabilities that eventually must be repaid. Those currently stand at $5.6 trillion.
“These auctions are going to continue to increase because the budget deficit is going to continue to widen, and the Treasury is going to have to fund that gap,” Charlie Ripley, senior investment strategist at Allianz Investment Management, said in a phone interview.