Rising bond yields (^TYX, ^TNX, ^FVX) are putting fiscal deficits in the spotlight.
Vanguard global chief economist and global head of investment strategy Joe Davis joins Market Domination to break down how structural debt could pressure interest rates and the broader economy.
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Do me a favor, Joe. Can you spell out for people who are watching, viewers who are watching who are not as steeped in the arcana of the bond market, why this is so important? Because for years, we have heard, um, concerns raised about these deficits and the potential effects and we haven't really seen those come to fruition. Why might that happen? And what could they be?
Sure. Sure. Should I give you three points? You know, one is, for anyone who hears the phrase deficit, that's just a gap between the taxes that a government brings in and then what is its spending on social programs, national defense, and interest costs. A deficit obviously, you're spending more than you bring in. Um, you know, when you're during when during recessions or periods of war, we've seen very high deficit levels and they don't necessarily have any impact on interest rates. You know, they're they're generally viewed as temporary unfortunate events, if it's a war or a recession, but they don't have this permanent effect of the the debt levels growing at an increasing rate. However, if it's what's called what's what economists call structural, which means every year, whether the economy is strong or not, we have, uh, uh, deficits growing. And part of the reason for that is, you know, we have strong commitments from Social Security, Medicare, Medicaid, and we have tax rates that don't fully cover those costs. And so, um, in our framework, uh, that is what can have an impact on interest rates, higher borrowing costs for the for the Treasury to issue debt, and then all the interest rates tied to that, mortgage rates, auto loans and so and so forth again. We're not at alarming levels yet. I don't think we'll be there tomorrow, but we started putting our finger on this dynamic two years ago. And so if we do not see a stabilization in our deficit levels, uh, we could see further upward pressure, uh, on the bond market. And that's precisely the scenario we talk about, uh, in the book released today.