If you’re a global bond investor, you’ve had a lot to fret about lately. Government deficits are out of control, inflation is stubborn, and geopolitics, from trade wars to actual wars, threaten to make both worse.
It also hosted this year’s G-20. Many on Wall Street applauded Bessent’s early advocacy of a 3% of GDP deficit target, but neither Trump nor Congress signed on. Nonetheless, all eyes naturally turn to the U.S. for leadership at moments like this. It has the largest and most important bond market, the most influential central bank, and the reserve currency. It started the war with Iran, and can presumably end it. Unable to change the fundamentals, Bessent is tinkering with the symptoms: a surprise boost to bond buybacks, which he characterized this week as an effort to influence the speed of yields’ movement rather than their destination, or intervening to support the yen, whose drop he feared would roil the bond market. At a meeting with the Bank of Japan’s governor, he reiterated support for a stronger yen. Bessent offered little prospect of relief on those sources of inflation for which the administration is at least partly responsible. Asked about a trade war with Canada, another potential source of disruption, he ridiculed the idea that Canada was even big enough to wage such a war.
“The world is awash in debt…and the only way for us to get out of this is to grow our way out of this,” Bessent said at the start of the summit. As the U.S. resumed bombing Iran, driving up the price of oil, he predicted the Strait of Hormuz would be a “worthless piece of water” in two years. He might be right, but consumers want lower gas prices today.
If so, the Fed’s current interest rate setting of 3.6% isn’t particularly high; it might be the new normal. Second, an AI boom isn’t enough. In a recent paper , economists Doug Elmendorf, Karen Dynan and Louise Sheiner examined scenarios in which AI sustainably boosted annual productivity growth by a half to a full percentage point, with differing impacts on employment. In all scenarios, the debt keeps rising as a share of GDP, albeit more slowly than now. Third, better growth naturally leads to higher interest rates, which raises the interest bill on the debt. Indeed, that may be one factor at work now. Heady visions of AI’s potential have uncorked a tidal wave of AI-linked borrowing. But as Ajay Rajadhyaksha of Barclays explains, there are several reasons to nonetheless worry.
Because growth, thanks to AI, might be a bit faster, but also because inflation risks are more ubiquitous, whether from supply disruptions or pressure on central banks to finance government debt, this is.
He said a key driver of this year’s yield run-up is that investors think short-term interest rates will be higher sustainably in the future.
