Introduction and Context

• Host: Richard Coffin from The Plain Bagel
• Topic shift from tariffs to treasury bonds due to recent market alarm
• Recent weeks: 20-year and 30-year US Treasury yields reached above 5%
• Nearly surpassed 18-year highs from 2023 before settling lower
• US Treasury bonds selling off despite being considered safest assets
• US government borrowing costs increasing substantially

Treasury Bond Basics

• Investment instrument allowing lending to US government
• Specified interest payment and time period (10, 20, 30-year terms)
• US government spends more than tax revenue, issues bonds to cover difference
• Interest rates generally factor of bond demand
• 2011-2023: average interest rate below 3%
• Recent increase: 20-year yield rose nearly 70 basis points in ~1.5 months
• 2025 refinancing challenge: $9.2 trillion (1/3 of total debt) needs refinancing

Federal Reserve Policy Impact

• Fed maintained high federal funds rate post-pandemic to combat inflation
• Current trade war expected to increase inflation again
• Fed Chair Jerome Powell expressing caution on rate cuts
• Markets pricing in delayed rate cuts due to trade policy volatility

Three Main Short-Term Factors for Yield Spike

1. Moody's Credit Rating Downgrade (May 16th)

• US rating downgraded from AAA to AA1
• Last of three agencies (Fitch, S&P, Moody's) to downgrade from highest level
• Reasoning: unsustainable spending trajectory
  • Interest expense: 9% of revenue (2021) → 18% (2024) → 30% (2035)
  • Federal deficit projected: 6.4% GDP (2024) → 9% GDP (2035)
  • Debt-to-GDP: 98% (2024) → 134% (2035)
• Interest already largest federal expense, topping defense and Medicaid

2. "One Big Beautiful Bill" Act Budget

• House passed $4 trillion debt addition over next decade
• 10,000+ page bill including:
  • $25 billion Golden Dome Missile Defense System
  • Trump accounts (formerly Omega accounts): $1,000 for newborns
• Spending cuts: 7.6 million cut from Medicaid, food aid reductions
• $330 billion from student loan repayment restructuring
• Tax cuts primarily benefit higher income brackets
• Senate expected to make further deficit-reducing revisions

3. Lackluster 20-Year Bond Auction

• $16 billion auction reached yields as high as 5.046%
• Previous month: 4.81% for $13 billion auction
• Six-auction average: 4.613%
• Demonstrated decreasing investor appetite for US treasuries

Japan Treasury Holdings Speculation

• Claims Japan (largest foreign holder) selling hundreds of billions
• Potential reasons: retaliation to US trade policy or carry trade unwinding
• No official figures backing these claims
• Experts cast doubt on meaningful reduction in Japanese holdings

Economic Implications of Rising Yields

• Treasury yields act as "gravity on the market"
• Higher yields pressure economic activity through:
  • Potential government austerity measures
  • Benchmark for other interest rates
  • Mortgage rates rose to nearly 7%
  • Increased default risk from expensive refinancing
  • Stock market pressure (reduced attractiveness vs bonds)

Banking Sector Risks

• Banks hold significant long-term fixed income securities
• Assets acquired during low interest rate periods post-2008
• $500 billion in unrealized losses across banking system
• Many securities classified to prevent losses showing in income statements
• Concerns about Silicon Valley Bank-style collapse

Risk Assessment and Counterarguments

Why This Isn't 2008 or SVB Repeat

• Not first time for higher Treasury yields in recent years
• 20/30-year yields still below 2023 18-year highs
• People historically poor at predicting crises

Credit Rating Context

• AA1 still very high rating
• In line with/higher than 4 of 7 G7 nations
• Only Canada and Germany maintain AAA at Moody's
• Moody's upgraded outlook to "stable"
• Noted US strengths: economy size/resilience, USD reserve currency status, Fed independence

Banking Sector Differences from SVB

• Large banks have significant derivative contracts for interest rate risk management
• SVB had minimal hedging (hundreds of millions vs hundreds of billions in deposits)
• Bank runs less likely for large institutions (JP Morgan, Bank of America)
• Current balance sheet losses less than two years ago
• Banks typically earn more when interest rates higher

Debt Sustainability Context

• Many developed nations have higher debt-to-GDP ratios
• Household debt declined since 2008: 6 percentage points drop since 2022
• Economy better positioned to handle higher rates

Federal Reserve Tools

• Rate cuts available
• Quantitative easing option (direct bond purchases)
• Fed balance sheet slowly decreasing since pandemic
• Multiple intervention levers available

Trade Policy Implications

• American protectionism could impact treasury demand
• More US isolation = less demand for USD and Treasury bonds
• Affects government's ability to raise money

Conclusion

• Real risks exist but likely not imminent crisis
• Situations tend to be slower-moving than social media suggests
• Important not to overreact to alarmist posts
• Multiple variables and players will impact outcomes
• Prediction of exact timing/impact nearly impossible