Chart of the Week

Aside from tax and spending cuts, the July 4 reconciliation bill lifted the U.S. debt ceiling by $5 trillion according to CBO estimates, accommodating expanded government borrowing for the next three years. The bill increases cumulative, 10-year deficits by $3.3 trillion, largely financed by an estimated increase in tariff revenue. However, even accounting for the estimated tariff revenues over the next decade, U.S. deficits are historically elevated.

As the chart shows, the budget deficit is on track to remain above 6% as a percentage of gross domestic product in the coming years, well above the roughly 3.5% average during the two decades before the coronavirus pandemic. With the consequent rise in the U.S. Treasury’s already elevated interest expenses, we believe that growing debt-service costs risk becoming an increasingly important driver of longer-term yields in the bond market.

As the Treasury uses its borrowing authority under the new debt ceiling to increase issuance and rebuild its cash balances in the coming weeks, we expect that volatility in yields may increase. This volatility is a main reason why our investment preference has shifted away from longer-term to intermediate-term (three- to seven-year) maturities.

Each asset class has its own risk and return characteristics. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Bonds are subject to market, interest rate, price, credit/default, liquidity, inflation and other risks. Prices tend to be inversely affected by changes in interest rates. Although Treasuries are considered free from credit risk they are subject to other types of risks. These risks include interest rate risk, which may cause the underlying value of the bond to fluctuate.

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