Bond yields near 5% squeeze Main Street as Warsh weighs Fed

Long-term Treasury yields are climbing toward 5 percent, steepening the yield curve and lifting borrowing costs for American households even as the Federal Reserve keeps its policy rate unchanged.

"The higher bond yields on long-dated securities clearly indicate discomfort over persistently high inflation in the future," said Lawrence Yun, chief economist at the National Association of Realtors.

The 10-year Treasury yield traded above 4.7 percent Tuesday, up from below 4 percent before the Iran war began in late February, while the 30-year yield touched 5.323 percent, a 19-year high. The spread between 2-year and 10-year yields has widened by nearly 29 basis points since June 24. A 30-year fixed mortgage now costs 6.75 percent, and a gallon of diesel runs $5.46, up 48 percent from a year ago, according to AAA data. The effective federal funds rate stands near 3.63 percent, leaving a wide gap to the 10-year yield that shows investors demanding far more compensation for lending over decades than for short periods.

The squeeze is hitting Main Street even as Wall Street prospers — the S&P 500 has returned 77 percent over three years, with stock holdings concentrated among the wealthiest Americans. With the federal deficit set to reach $2.1 trillion, or 6.4 percent of GDP, and no plan to cut it, the bond market's grip on household finances may persist well beyond Fed Chairman Kevin Warsh's Jackson Hole speech on Aug. 28.

What's driving the sell-off

The run-up in yields stems from an unlucky confluence: Iran-war energy prices, an insatiable appetite for debt to fund AI data centers, and large federal deficits. Oil is trickling out of the Middle East and U.S. refineries run near capacity, while tech companies compete with the government for investor capital. Supply-chain bottlenecks for chips and an aging electricity grid have pushed prices higher, flipping technology from a force for slower inflation to one that raises prices in aggregate.

Investors' inflation expectations, measured by 5-year breakevens, are essentially flat, keeping a floor under long-term yields. But finger-pointing over the trigger "misses the point," said Robin Brooks, senior fellow for economic studies at the Brookings Institution. "When you have a lot of debt and run unsustainably large budget deficits, you're extremely vulnerable to any old shock that comes along."

The U.S. budget deficit is set to come in around 6.4 percent of GDP, based on the Congressional Budget Office's estimate that it will hit $2.1 trillion for the fiscal year through September. The Trump administration has cited one-time military costs from the Iran war and wage gains for lower-income households, but has no obvious plan to cut deficits.

What Warsh can — and can't — do

Warsh has expressed sympathy for Americans battered by high rates, arguing financial conditions are restrictive on Main Street — particularly in housing — but loose on Wall Street. In July he seemed to welcome the rise in yields, saying, "At some level, we haven't done much in 42 days. The markets have done quite a bit." Traders responded by pushing rates still higher, and have scaled back bets on near-term cuts as economic data stays resilient.

He has argued the Fed juiced Wall Street by putting trillions of dollars of Treasurys and mortgage securities on its balance sheet, but has yet to convince the rest of the Fed to reverse that. A reduction in balance-sheet holdings would, in the short term, add more upward pressure on long-term Treasurys and mortgages.

Warsh takes the stage at the central bankers' conference in Jackson Hole on Aug. 28, where he is likely to address the economy and the bond market's relationship with the Fed. His views on the balance sheet will likely wait for a Fed task force report in a few months.

A speech may help stem the sell-off and ease the pain on Main Street, but one speech can only do so much — the Fed cannot directly fix the balance of government spending and revenue. At some point, yields will fall as buyers return, a cycle repeated in recent years as the 10-year edged toward 5 percent, threatened stocks, then tumbled. Unless it eases, the slow-burn pressure will almost certainly fuel a political crisis.

This article is for informational purposes only and does not constitute investment advice.