Once regarded as one of the safest assets in the world, U.S. Treasuries are now seeing their safe-haven status increasingly questioned.
Recently, yields on 20-year and 30-year U.S. Treasuries both briefly surpassed the critical 5.1% threshold, drawing heightened attention to a sustained selloff in long-dated government bonds. This surge in yields reflects deepening market concerns over the United States' widening fiscal deficit, rising debt levels, and mounting interest burdens. The upward trend in Treasury yields is also prompting global capital to shift toward other markets.
Against this macro backdrop, Fitch Ratings has issued a warning on the fiscal outlook of the United States. Richard Francis, Senior Director of Sovereign Ratings at Fitch, recently noted: “Even if there is a temporary improvement in the U.S. fiscal deficit in 2025, it is expected to widen again due to the extension of tax cuts and slowing economic growth. By 2026, the U.S. debt-to-GDP ratio is projected to reach 120%, more than double the AA rating median. The interest-to-revenue ratio is also expected to exceed 13%, the highest among similarly rated sovereigns.” He emphasized that if the coherence and credibility of U.S. fiscal policymaking deteriorates, it could undermine the dollar’s reserve currency status and the government’s financing flexibility.
In light of these evolving dynamics, Southern Finance conducted an exclusive interview with Brian Coulton, Chief Economist at Fitch Ratings, to explore current bond market volatility, U.S. inflation prospects, the Fed’s policy trajectory, and the latest developments in U.S.-China trade negotiations.
Southern Finance: What factors do you think contributed to the turbulence of the bond market?
Brian Coulton: Yeah, the high level of US treasury yields in recent months has been quite interesting, given that most forecasters are expecting the US economy to slow down. And normally, you associate that with a prediction that the Federal Reserve would cut interest rates, and that generally would lead to lower bond yields.
But we've not seen that, I think a couple of reasons. I think one is that the tariff shock is, as an adverse supply shock, it's going to have an inflationary component. So that's something that's going to have an influence on the Federal Reserve.
Maybe not seeing rate cuts as quickly as you would normally expect, given the anticipated slowdown in the economy. But I do also think that we are seeing evidence, over the last 6 to 12 months, that the bond market is getting a bit more concerned about supply issues. And the context here is, of course, the Federal Reserve is reducing its holdings of treasuries through the QT program a bit more slowly, but it's still offloading its portfolio.
And so the treasury has to rely more on the market. And the reality is that the fiscal deficit is still very, very large and there's a lot of supply that the market has to absorb. And I think that's putting downward pressure on bond prices.
Southern Finance: I've also read in your recent report, you said that you believe the U.S. inflation would be around 4 percent, which is far above the 2 percent, the Federal Reserve's target, especially with household inflation expectations raising significantly. So how do you think this would impact the Federal Reserve's monetary policy trajectory in the near term, as well as in the long term? How many cuts do you project for this year?
Brian Coulton: We're only projecting one Federal Reserve cut this year, not until the fourth quarter of the year. So we think they're going to be on hold for quite some time. As I say, despite our expectation that the U.S. economy is going to slow down.
Now, we published in mid-April a forecast that inflation in the U.S. would go to 4.3 percent. That's maybe looking a little bit on the higher side now, given the recent de-escalation in the U.S.-China tariffs. But even so, we definitely think there's going to be upward pressure, particularly on goods prices, as these increased tax rates on imports feed through to higher prices for U.S. consumers.
At the same time, the other aspect of the Fed's dual mandate, the employment side, is still looking OK. I mean, unemployment is still quite low in the U.S. The labor market still looks relatively tight. So they don't have that much to worry about at this point on the employment mandate.
And yet inflation is still above their target, if you look at the core numbers, and it's going to rise. And I think that's going to cause a lot of hand-wringing at the Fed. And I think the way they will respond to that is basically to sort of sit tight for quite some time.
Their view is that interest rates at the moment are still above what you would call a neutral rate, a rate that doesn't neither boost nor depresses the economy. And so they still think that they've got a little bit of a tight policy stance, and that continues to be appropriate given this increased inflation that's coming.
But also, as you mentioned, we've had three surveys now from the University of Michigan and also the New York Fed survey showing households really are worried about inflation.
I mean, we've seen three to five year ahead inflation expectations go back to levels we really haven't seen since the early 1990s. Now, that potentially is a threat to the Fed's credibility. So we've got to be really careful about cutting rates into this environment, cutting rates too quickly.
Southern Finance: You just said that the labor market right now still looks fine. It's pretty tight right now at this moment. However, recently St. Louis Federal Reserve President mentioned that business investments and hiring intentions are starting to soften. So did you observe the similar trends or you have different opinions?
Brian Coulton: I think we need to sort of distinguish here between what you call the soft data and the hard data. So the soft data, you're asking businesses what they're going to be doing, you're asking households what they're expecting.
Those surveys have definitely deteriorated, no doubt about it. Sentiment has fallen quite sharply and hiring intentions in some of these business surveys are definitely deteriorating.
But if you look at the hard data, sort of weekly jobless claims, which are a pretty, pretty high frequency real time indicator. You look at the payrolls reports, you look at the unemployment rate, none of those indicators are suggesting the labor market is really suffering at the moment.
So I think the negative impacts of all this on employment and hiring are going to take some time to come through. I think it's going to be, we're going to be seeing the price impacts more quickly than we're going to be seeing the labor market impacts.
Southern Finance: So how might prolonged trade uncertainty as well as inflationary pressures affect Fitch’s outlook for US GDP growth?
Brian Coulton: I think one key aspect is if you look at measures of policy uncertainty, they've gone through the roof. So there's an index which spiked in the pandemic.
And up until March, it had almost gone back up to that level. But then the April reading was just off the charts, the highest ever recording for policy uncertainty.
And I think that's going to affect the way consumers and businesses conduct their everyday spending decisions.
I think firms are going to be putting business investment decisions on hold. Now, how quickly that feeds through to the actual investment numbers. A lot of the CapEx that's done in any particular quarter reflects decisions taken, particularly years ago, these are five-year projects and stuff.
So it might take some time, but I think there's definitely going to be an impact on the willingness of firms to start a new project. And I think that could weigh on investment over time. And if you've got slower investment, you're going to have slower growth in the capital stock, less capital deepening, that's going to weigh on productivity.
So I think there are going to be some medium-term negative impacts on growth from all this.
Southern Finance: Looking ahead, what key monitors or what key developments would you be watching closely to observe the global economic cycle?
Brian Coulton: I think the first thing we'll be looking for, that we're likely to see is evidence of a tariff shock on prices. Now, we didn't really see much in the April CPI, but they only really started raising tariffs aggressively in March and then obviously in April itself.
And we know that firms did quite a lot to bring forward, US firms did quite a lot to bring forward their imports from the rest of the world before the tariff hikes kicked in.
So there's got to be a delay there, but I do think as we get into the early summer months, we will see the impact on prices.
And then it's just seeing what happens to business investment, what happens to consumer spending, there's going to be a negative real wage shock for the US consumer.
So it will be the consumer spending, business investment data, and that labor market data. The US has very good high frequency labor market data monitoring that to see if there's a negative impact on activity, which we do expect to become increasingly visible as we're getting to the third and fourth quarters of this year.
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