In the past month interest rates have been going up—a lot. Most of the action has occurred at the long end of the yield curve (10 to 30 years). A year ago, there was not a lot of difference between the yield on a 10- and 30-year US Treasury bond. As of last Friday, the 30-year bond returns about 5 percent, whereas the 10-year bond is quoted with a yield of about 4.5 percent which is close to this time last year. While this may not sound like a lot, remember that an extra half percentage point in borrowing cost over 30 years comes to 15 percent more interest over the same period. When you issue bonds by the billions like the US Government does, this is real money.
Until recently, it was a Wall Street parlor game to speculate how many times the government would reduce interest rates in 2025. That game has stopped, as estimates have gone from five to zero. Until February, there was talk of the yield curve (the plot line of all interest rates at various times to maturity) going from flat (where it was a year ago) to upward sloping with the most immediate time to maturity dropping. At the best of the Federal Reserve this would have had the effect of lowering short-term rates and steepening the yield curve. Instead, short-term rates are steady compared with a year ago and long-term rates have gone markedly higher. In effect, the curve steepened the wrong way from an interest expense perspective.
The abrupt rise in Treasury bond yields came about from the barrage of tariff threats originating from the US Government. Foreign investors in the US have curtailed their purchases of American debt and have collected their principal instead of rolling it over to a new bond. The reality is that the US savings rate is not high enough to assimilate the supply of debt being generated by the government’s overspending. This makes the US bond interest rates hostage to foreign demand.
This vulnerability will continue so long as the country grows its deficits at a rate higher than the US growth rate. This makes the administration’s “big, beautiful” tax bill a point of consternation. It is slated to increase the deficit by $3.8 trillion over ten years as currently configured. It is slated to be taken up by the Senate after passing the House of Representatives by one vote. It will likely be a source of market instability.
Another potential source of instability will be the need to authorize an increase in the debt ceiling. The country is slated to run out of borrowing authority by July or August. Adding the tax and spending bill to the mix will make for an interesting summertime in Washington, DC. Stock investors have by and large not gotten the memo on the impact of higher rates on the economy and stocks themselves. Since tariffs were unveiled on April 2, the markets have whipsawed to the point they are now about where they were on inauguration day. Whenever the White House threatens to raise tariffs, the market sells off. When tariffs look like they may be
lowered for a large trading partner, stocks rally. The most recent example of this is last week, when the President threatened to impose 50 percent tariffs on the European Union (EU), a collective of 27 European countries. He also threatened additional tariffs on Apple cell phones not assembled in the US. After talking to the EU trade representative, Trump extended the deadline for tariff
negotiations to July 9 from June 1. This caused the stock market to go up. All very Pavlovian. What the stock market is not focusing on is the damage being done to the economy by the constant revelations of what is at hand. Some see this as brilliant negotiation skills. Keep your opposite off balanced. Others see this as nothing short of the Mad Hatter’s Tea Party. Our nation’s friends are perplexed and alarmed. Our adversaries cannot believe their good luck as they try to court those who once aligned with us, and we with them.
Economic data shows little movement thus far. This is mainly the result of heavy imports and exports made in advance of the tariffs taking hold. Future data will swing the other way before concise readings can be made. It is already obvious that consumers are putting off major purchases due to economic uncertainty. Travel plans have been curtailed, and dining traffic is down. People do not know the level of tariffs to be imposed and thus do not know what items will cost. The focus on the latest market rebound has been on, for the most part, the same seven names that have led the advance in years past. This may be their last hurrah. They are somewhere in the ninth inning.
The Economy
For an economy with rising interest rates and no signal from the Federal Reserve or the Treasury that cuts are on the way, it would seem the economy would reflect more challenges than is currently the case.
At some point, probably early fall, there will be more reliable economic data that will have the effects of tariffs, tax changes and foreign buying all incorporated. If this leads to consumers deciding to spend less, then the economic impact will likely be more permanent.
Inflation
The tariffs incorporated with the fall of the US dollar will be inflationary. No one knows yet to what extent because final tariff taxes have not been negotiated.
As less foreign demand is incurred for US government bonds, interest rates will have to be increased to attract buyers either international or domestic. If the latter the purchase of bonds may deprive the economy of the demand the dollar value of the bonds represent. The only other option is for the government to print enough money to cover the deficits, but this would risk another Weimer Republic situation. At a minimum, interest rates need to be higher than the inflation rate.
Interest Rates
Interest Rates will likely continue to elevate for quite some time. They will need to be above the inflation rate to have credibility in reigning in the same. The inflation rate of other counties like Japan can impact our own interest rates. As Japanese bond yields rise, it will take ever higher yields from the US to compete. In addition, there is the risk of currency devaluation which is not present in the investments in one’s own country.
The Stock Market
The stock market feels on the cusp of a major transition. Large tech companies are beginning to eye each other’s businesses, a sign that growth opportunities are slowing. On the other hand, higher interest rates and inflation means that returns both in terms of cash flow and appreciation will come back into favor.
Industries of note would include defense, select utilities, health care, energy, industrial companies that have some sort of edge, consumer staples, and the like.
Warren M. Barnett, CFA
May 29, 2025
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