Erik Norland, CME Group
AT A GLANCE
- As the budget deficit shrinks, more U.S. Treasury issued debt is finding its way onto the market, possibly putting upward pressure on long-term borrowing costs.
- Higher inflation and the Fed’s decision to begin raising short-term interest rates are major contributing factors to the rise in long-term borrowing costs.
What impact does the supply of debt have on long-term interest rates? And who controls the supply of long-term debt to the markets?
Long-term rates have been rising sharply in recent months pushing up the borrowing costs for governments, corporations and for anyone who wants to take out a mortgage.
Higher inflation and the Fed’s decision to begin raising short-term interest rates are major contributing factors to the rise in long-term borrowing costs.
The supply of debt coming onto the market also influences long-term borrowing costs. During the pandemic, the U.S. budget deficit grew from 5% of GDP to nearly 20%. But during this time long-term bond yields actually fell, in part, because the U.S. Federal Reserve bought $4.8 trillion of debt roughly equivalent to 20% of GDP. So, the U.S. Treasury supplied record amounts of debt but the Fed took the debt back off the market.
During the past year, the U.S. budget deficit has fallen in half but it remains very large at around 9% of GDP. Meanwhile the Fed, first tapered its borrowing and now plans to sell $95 billion per month back onto the market, putting debt equivalent to about 5% of GDP back onto the market. The net effect may be that even as the budget deficit shrinks, more U.S. Treasury issued debt finds its way onto the market, possibly putting upward pressure on long-term borrowing costs.