US Treasurys: In Eye of The Storm

Explaining the Rising Concern

Investors have expressed concern from time to time about the size of the US fiscal deficit. However, the Secretary of Treasury has not felt the need to assert that the government will not default on its obligations — until now. “I will say the United States of America is never going to default,” Scott Bessent said on CBS “Face the Nation” program last Sunday responding to anchor Margaret Brennan’s concern over the need to increase the debt ceiling by mid-July, and how close to default the Treasury may come in the process.

Is all the fresh concern about the debt and deficit just another instance of crying wolf?There are at least two reasons to suggest that today’s danger is real. First, unlike in the 1940s when the surge in the fiscal shortfall was largely because the nation was at war, the United States is experiencing a deficit approaching 7% of gross domestic product during a period of relative peace. Also, the US economy is continuing to grow rather than be in recession which would have cut into government revenues.

Second, there is no sign of efforts being made to bring the fiscal balance under control despite the enormity of the problem. The Big Beautiful Bill incorporates a $4 trillion increase in the debt limit at a time when interest payments are already running at an annual rate of $1.1 trillion, exceeding the amount spent on defense during 2024.

Will the new fiscal program passed by a slender one-vote majority in the House of Representatives, and awaiting consideration at the Senate, lower the deficit? Put differently, will economic growth pick up sufficiently for rising tax revenues to reduce the shortfall? Such promises of fiscal efficiency are almost never kept due to how the process works — an exaggeration of the projected revenue inflows even as the expected spending cuts get postponed or annulled as a political necessity.

With a concern for the fiscal situation that he had not shown until the past week, Elon Musk, President Donald Trump’s erstwhile head of the Department of Government Efficiency (DOGE), criticized the Big Beautiful Bill as a “disgusting abomination.” He warned of the crushing debt that would ensue if the program is actually implemented. A number of business leaders have joined the chorus in expressing in public their concern over the adverse impact the Bill would have on Treasury yields and the pace of economic growth.

A saving grace in the current situation would be that the Bill may not get Senate approval after all. Musk’s split with the President came into the open last week with Musk suggesting that he would use his resources to oppose the reelection of House members who had voted for the Bill. The President responded by saying on Truth Social that “he {Musk] just went CRAZY!” and threatened to cut government contracts for Tesla.

Assume though, that the Bill is approved and becomes law. How would we see the impact on financial markets? For one thing, the yield on 10-year Treasurys which are still trading at around 4.50% — an elevated level but that by no means suggests panic — could surge overnight, reminiscent of what happened after the tariff announcements on April 2 (“Liberation Day”). I am sticking with my expectation of 5% on the 10-year by year-end and 5.75% for 30-year obligations.

A second way the financial impact would be felt is through what is referred to as a “failed auction.” In this situation, the Treasury loses its ability to place all the debt it offers at a reasonable yield. If a failed auction takes place, it is likely to occur with no prior warning signal. The bid-to-cover ratio — the ratio of total bids received to the amount available for sale — would, in that case, fall to less than 1.0. A failed auction would be a much greater shock to markets and to the US Treasury than a mere rise in the 10-year yield of, say, 25 basis points overnight would be.

These may have been among the concerns that prompted President Trump to call upon Federal Reserve Chairman Jerome Powell twice last week to reduce interest rates. Responding to the fact that the ADP numbers released Wednesday showed that the private sector created only 37,000 jobs in May, the lowest since March 2023, the President pushed Powell to lower rates. “ADP NUMBER OUT!!! 'Too Late’ Powell Must Now LOWER THE RATE",” he wrote on Truth Social. That the European Central Bank was about to cut the policy rate for the eighth time the following day only increased Trump’s insistence.

Despite the presidential pressure, the Federal Open Market Committee is likely to leave the Federal Funds rate unchanged when it concludes its two-day meeting on June 18. The upward pressure on inflation from the tariff measures is likely to register only in the second half of the year and it would be irresponsible to ease policy without having more information on the inflation outlook.

And yesterday’s nonfarm payroll report from the US Bureau of Labor Statistics showed the US economy created 139,000 jobs last month, a respectable number although less than the 147,000 new jobs in April. Notwithstanding the continued healthy employment numbers, President Trump referred to the Fed’s current policy as a “disaster,” and called upon Powell to lower the policy rate by a full percentage point.

However, Chairman Powell and the FOMC are unlikely to reduce the Federal Funds rate even by 25 basis points, let alone by the one percentage point Trump demanded. Why? The BLS report showed that average hourly earnings increased by 0.4% in May and by a still elevated 3.9% over the past year. The Fed can find no reason to ease policy in light of these figures.

As foreign leaders negotiating with the President have already realized, the presidential bite is in no way going to be as painful as the bark. Despite the further criticism that Powell may keep getting from Trump on Truth Social, he is safe in his position until his term ends.

Specifically, Powell understands that the President cannot legally fire him before his term ends next May and that the chances of his being reappointed to the post are zero.

Dr. Komal Sri-Kumar

President, Sri-Kumar Global Strategies, Inc.

Santa Monica, California

www.srikumarglobal.com

@SriKGlobal

June 7, 2025

Sri-Kumar Global Strategies, Inc. advises multinational investors and sovereign wealth funds on global risk and opportunities. Dr. Sri-Kumar is regularly featured on business TV and Radio media, and is a frequent speaker in global financial centers on major topics that affect markets and investments.

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