Treasurys lose safe-haven premium as US debt hits $40 trillion

Treasurys are losing their status as the world's safest asset as $40 trillion in federal debt forces investors to demand higher yields on U.S. government bonds.

The U.S. Treasury's safety premium has flipped into an absorption premium, with investors demanding roughly 0.75 percentage points more yield on long-term bonds since 2015 as federal debt crossed $40 trillion this week.

"When the government borrows this much and the rates for Treasurys go up, that brings up the rates for everything else, from mortgages to car loans to credit cards," said Michael Peterson, CEO of the Peter G. Peterson Foundation, which advocates for fiscal responsibility.

MIT economist Ricardo Caballero's recent study finds the shift from a safety premium to an absorption premium explains about 0.75 percentage points of the roughly 2.5 percentage point rise in yields since 2015. Stanford's Hanno Lustig reaches similar conclusions: Treasury yields have been generally higher than other sovereign bonds when hedged into dollars since the pandemic, and the yield advantage over AAA-corporate bonds has disappeared since 2022.

The erosion of safe-haven status carries direct costs. The Congressional Budget Office projects the deficit will reach $2.1 trillion this year — double the 3 percent of GDP target Treasury Secretary Scott Bessent once envisioned — while corporations plan a record $1.9 trillion in investment-grade debt issuance, much of it for AI infrastructure. If investors continue demanding higher yields, mortgage rates near 6.7 percent could climb further, and the U.S. faces rising rollover risk as it shifts financing from long-term bonds to short-term bills.

Bessent's Bond Market Intervention

Treasury Secretary Scott Bessent's surprise announcement Wednesday to boost buybacks of less-liquid longer-term debt treated the symptom rather than the cause. Yields fell initially but rebounded Thursday. The move, announced just two weeks after the last quarterly refunding, departs from the "regular and predictable" issuance framework that Treasury departments of both parties have followed since the 1970s.

"If issuance and buybacks are no longer regular or predictable, bonds might become more volatile," said Blake Gwinn, head of U.S. rates strategy at RBC Capital Markets. "Investors might demand a higher yield to account for this extra unpredictability."

Bessent has also intervened to support the Japanese yen, suggesting Japan borrow from the Fed to finance yen buying without selling Treasurys. He has shifted financing from long-term bonds to Treasury bills, increasing rollover risk — the chance that interest rates will have risen when short-term debt must be refinanced.

The buyback program, launched in 2024 to improve liquidity in little-traded issues, was previously scheduled at quarterly refundings. Bessent's off-cycle announcement caught investors offside, achieving its short-term goal of pushing yields lower. But the longer-term effect may be the opposite: if the Treasury is seen as managing the market rather than following a predictable schedule, investors could demand a larger uncertainty premium on every auction.

The Fiscal Path Ahead

The debt trajectory is structural, not cyclical. The government has run large deficits even during economic expansions, with spending on Social Security and Medicare rising automatically as baby boomers retire. Annual interest on the accumulated debt now tops $1 trillion, making it the government's second-biggest expense behind only Social Security.

"$40 trillion should be a wake-up call," said Carolyn Bourdeaux, executive director of the Concord Coalition, a deficit watchdog group. "Both parties helped bring us here, and both parties now have a responsibility to change course."

The last time Treasury yields rose this persistently was in the 1980s, when the Fed's inflation fight pushed the 10-year yield above 15 percent. Today's dynamics differ — the Iran war has driven up energy prices and inflation, while AI-linked corporate borrowing adds supply pressure. But the underlying message is similar: when investors doubt the fiscal path, they demand more compensation for duration risk.

The debt has doubled since 2017, and there is no sign the flood will abate. The Treasury Department has taken steps to limit the increase in long-term bond yields, but these measures do nothing to solve the underlying problem. Congress will ultimately have to raise taxes, cut spending, or — most likely — do both. While some lawmakers once proudly called themselves deficit hawks, fiscal discipline has generally fallen out of favor in Washington. Anxious signals from the bond market could change that.

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