The US Treasury Bond - Why All The Fuss?
Over the past few weeks, the financial news has been all over the place: The U.S. Treasury attempted to boost the value of the yen; the U.S. and Canada have entered into a trade war; foreign countries are gradually selling their Treasury bonds (money they have lent to the U.S.); yields on longer-term bonds are surging; the price of oil is rising with no foreseeable plan to halt; the AI boom is dominating the stock markets; our national debt recently exceeded forty trillion dollars, and the Fed just raised interest rates by another quarter of a percent. Each piece of news, directly or indirectly, points to rising borrowing costs in the bond market, particularly for the U.S. Treasury. I want to explain what is happening in the bond market and how it affects short-term and long-term investment strategies.
We typically associate investments with the “stock” market – a place to trade shares of ownership in other companies. The company receives funds when it first issues shares, typically through an Initial Public Offering (IPO). However, after the IPO, subsequent trades occur in the secondary market – that is where most of the action takes place.
The bond market works a bit differently, but the issuer's incentive remains the same: they need funds. They can either borrow by issuing bonds or raise capital by selling common shares. This also applies to the U.S. Government, which issues Treasury Bonds to fund public spending and the national debt. Let’s explore the key elements of recent Treasury bond market news and how they can impact investment portfolios.
What is a Treasury Bond?
A Treasury Bond (T-Bond) is a long-term, fixed-interest debt security issued by the U.S. government to fund public spending and national debt.
How Treasury Bonds Work
Maturity: They are issued with long-term maturities of either 20 years or 30 years.
Interest Payments: They pay a fixed rate of interest (coupon) twice a year until they mature.
Principal Return: When the bond reaches its maturity date, the government returns the full face (par) value to the investor.
Purchasing: You can buy them directly through the U.S. Department of the Treasury via TreasuryDirect or secondary markets through banks and brokers.
Key Characteristics
Safety: Because they are backed by the "full faith and credit" of the U.S. government, they carry virtually zero default risk and are considered safe investments.
Tax Benefits: The interest earned from T-Bonds is exempt from state and local income taxes, though it is still subject to federal tax.
Liquidity: They are highly liquid and can be easily bought and sold on the secondary market before they mature. Market prices fluctuate inversely with prevailing interest rates.
What is the current problem facing the Treasury?
Investors are simply demanding a higher return for lending money over the long term. Yields on 10-, 20-, and 30-year bonds are surging as external risks become more evident.
Because of the pressure oil prices are putting on everyday items, inflation is a potential risk now and in the near future. Investors, both domestic and global, are demanding higher yields (the 10-year yield surpassed 5.0% today).
For any new Treasury borrowing, long-term rates on its IOUs are increasing, which translates into higher interest costs added to the annual interest cost on our $40 trillion national debt.
Interest paid by the Treasury in Fiscal Year 2026 (Oct-Sep) is expected to reach $1.3 trillion, with an average interest rate of 3.49%. Fiscal Year 2027 will likely have a higher average interest rate as rates rise; interest paid could reach about $1.6 trillion. The total deficit is over $40 trillion, and there does not appear to be a solid plan to reduce or even slow debt growth. The Debt-to-GDP ratio currently stands at 122% (it was 36% in 1980). ¹
¹National Debt Clock (https://www.usdebtclock.org/#)
It appears that the Treasury and the Fed are not on the same page; Why?
The Treasury wants growth fueled by productivity gains from business expansion, which requires funding, preferably at lower interest rates. The Treasury secretary has stated that AI-related growth will eventually generate the revenue needed to balance the national budget, cover spending needs, and ensure the U.S. remains at the forefront of AI technology for future national security. It appears that higher interest rates will be sacrificed, if necessary, to protect the booming investment in Artificial Intelligence (AI), with 8 trillion dollars reportedly ready to be borrowed.
On the other hand, the Fed (Federal Reserve) monitors the nation’s money supply and makes monetary adjustments as needed. If the economy gets too hot, it reduces the money supply by raising interest rates; if the economy slows, it increases the money supply by lowering rates. Raising or lowering interest rates is the most common and newsworthy tactic, but the Fed can also adjust bank reserve requirements and buy and sell government and corporate bonds.
Why are Yields Rising?
Demand for long-term bonds has declined because longer-term borrowing carries more uncertainty, especially regarding inflation. The longer you receive payments without inflation protection, the greater the loss of purchasing power. Longer-term investors demand compensation for the additional risk of long-term lending versus short-term lending.
A combination of inflation expectations and concerns about government debt is deterring investors from making long-term loans. I might have no problem lending my brother-in-law a down payment on a short-term note – a year or two. But if the note’s maturity is 20 years away, I have additional concerns – will he be around? What will interest rates be? Is there any collateral?
Investors are demanding a higher rate of return on loans to the U.S. Government. It’s not the risk of credit default that bothers them (there is no default risk); it’s that the dollars they receive may be worth less in the future. In addition, global investors have noticed that our national debt has exceeded $40 trillion, and our actions across the globe over the past few months have diminished confidence in the U.S., which may translate into higher yields lenders demand.
What are the consequences of rising yields?
Borrowing costs for businesses and individuals will rise. Higher Treasury yields will eventually affect other borrowers – mortgage, credit card, student loan, and personal loan borrowers. Higher interest rates on credit cards, student loans, and personal loans will reduce an individual’s disposable income for other purchases. Higher mortgage rates can reduce the economic multiplier effect of home purchases and may deter homebuilders from constructing new homes.
Will rising yields have a negative impact on the U.S. and Global Stock market?
Historically, rising interest rates have hurt the stock market. Stock prices reflect expectations for future company earnings. As noted above, higher interest rates across all types of debt will increase debt payments, reduce discretionary spending, keep thousands of prospective homebuyers on the sidelines, and delay the positive economic impact of home purchases. In addition, higher oil and gas prices are reducing how much consumers spend on other items. Consumer spending makes up two-thirds of our GDP.
What can be done to stop yields from rising?
The inflation picture must be addressed before the market settles and bond yields stop rising or start falling. As long as the Middle East crisis continues, upward pressure on oil prices will deter investors from buying U.S. Treasuries, pushing yields higher to entice them.
Should Bonds Be in a portfolio? Why?
Bonds should absolutely be part of everyone’s portfolio. They are IOUs that pay a fixed rate of return, and many are virtually guaranteed (U.S. Treasury bonds). Stock performance is not an IOU to the investor; it is a claim on future profits. Bonds are less volatile than stocks.
When one speaks of a “60/40” allocation between stocks and bonds, the “40” represents the portion allocated to the less risky asset classes, such as CDs, money market funds, and short- and long-term bonds issued by various issuers (government, corporate, and municipal).
The benefits of owning bonds in a portfolio:
1) Stability – lower volatility creates a valuable cushion against the risks of stocks, real estate, and commodities.
2) Income received – The interest payments from a bond can lower the relative risk of a bond since cash is being received periodically instead of relying on stock appreciation.
At Carr Wealth Management, we manage client portfolios that include bonds with varying maturities and credit quality, both of which are primary determinants of bond yields. In addition, Anthony Carr has been a CPA for 38 years, and we offer tax expertise alongside quality investment management. Please call (925) 484-1671 or email us for a no-charge consultation to discuss your portfolio strategy, tax situation, planning needs, and future objectives.
