WSJ
The Era of Free Government Is Over
Rising bond yields around the world signal new fiscal realities.
Say what you will about 2025, the year is off to a rocky start for anyone who needs to figure out how to fund a government. Bond yields are rising across the developed world, raising some awkward questions about when politics will catch up with new economic realities.
In the U.S., 10- and 30-year Treasury yields are rising again with the 10-year above 4.6% and the 30-year around 4.9%. Yields already had lifted off from their pandemic-era lows as the Federal Reserve increased short-term rates and reduced its bond holdings to fight inflation. But the yield rise of recent weeks is happening after the Fed cut short rates substantially starting in September, and as the pace of its balance-sheet reduction has slowed since the spring.
As go U.S. bonds, so go borrowing costs in the rest of the world. The 10-year Japanese government bond, at nearly 1.2%, is at a level last seen in 2011. The German 10-year bund, the eurozone’s benchmark, is at a five-month high above 2.5% after a steep ascent in the past month.
You can pick from among several theories to explain this, all of which may play some role. In the U.S., a benign explanation is that investors expect stronger economic growth under President-elect Trump’s tax and regulatory policies. Less benign is concern that the Fed has cut rates too much, too soon and is willing to accept more inflation than its 2% target.
Investors in German bunds presumably are responding to political uncertainty after Chancellor Olaf Scholz’s administration collapsed last year, setting up a Feb. 23 election. Politicians are becoming more willing to water down the balanced-budget amendment—including the center-right Christian Democratic Party that is likely to win. This as the economy is in a tailspin, with negative implications for tax revenue.
Investors in U.S. Treasurys could share a similar fear. The incoming Trump Administration promises to wring more efficiency out of the government, and deregulation and tax reform can boost economic growth. But he also staunchly refuses to reform the entitlements that are the biggest drivers of federal deficits, and the shape of his tax and tariff policies isn’t clear.
A reminder of the worst-case scenario (short of outright default) comes from the United Kingdom. There, this week’s 4.8% rate on the 10-year government bond, or gilt, is the highest since 2008 and the 30-year gilt at nearly 5.4% is at its highest in several decades.
Investors seem to be losing faith in the Labour government’s ability to deliver economic growth or tame inflation. The tax-rising budget that Chancellor of the Exchequer Rachel Reeves unveiled in October prompted businesses to warn of scaled-back hiring and investment, and she and Prime Minister Keir Starmer lack any other plausible plan to revive an anemic economy.
This threatens a fiscal crunch. Ms. Reeves has promised no further tax increases—and the economy probably can’t bear heavier taxation anyway. Higher debt-service costs and lower expected economic growth are eating into her fiscal margin for error. London is speculating about which painful spending cuts will come if the bond vigilantes don’t relent.
Think the U.S. is immune? Interest repayments on federal debt already are higher than defense spending. Ultralow interest rates allowed the enormous spending expansion of the post-2008 era, and the dollar’s status as a reserve currency gives Congress more leeway to borrow than is healthy. Presumably this privilege isn’t limitless.
As for the rest of us, a note of caution: The financial fiascoes of the past few years have centered on supposedly ultra-safe government bonds rather than exotic assets such as subprime mortgages. This was true of the 2022 pension-fund-driven gilt meltdown in Britain, and the 2023 Silicon Valley Bank implosion.
No one is immune from a widespread repricing of risk, no matter how safe they think their balance sheets are. It’s still possible to imagine the U.S. economy will come safely through higher bond yields and macroeconomic uncertainties, but markets are sending a message that the era of “free” government is over.
