To pass a law in the United States, you need to jump through a lot of hurdles.
A bill has to first clear a committee in the House or Senate. (In the case of Republicans’ tax legislation this year, its components had to clear 11 different committees.) The House Rules Committee has to agree for it to come to the floor for a vote. It has to pass that vote. In the Senate, it has to get 60 votes to beat a potential filibuster, or else obey a set of byzantine rules allowing it to pass with a simple majority.
But another entity gets a vote, an entity not mentioned in the Constitution or in congressional rules or even physically located in Washington, DC. That entity is the bond market, and right now, it is very pissed.
Currently, the US makes up for any budget deficits it incurs by issuing bonds of various durations to cover the difference. It auctions those bonds — essentially IOUs issued by the Treasury Department — on the open market, where investors (banks, hedge funds, foreign central banks, pension funds, etc.) can bid on them.
To get them to bid, the US has to pay interest on the bond. And when the US borrows a lot, and especially if its fiscal policy indicates that the country may reach a point where it can’t pay back what it owes, investors will demand to receive more interest to compensate for the risk of default. That means the US has to pay more every year to service its past debt, and those payments in turn become future debt. If the interest they demand is high enough, the result can be an economic downturn, an upward debt spiral, or both.
While politicians pay attention to all kinds of economic indicators, from the unemployment rate to the stock market, the bond market is a different and more powerful animal. The most famous quote about the bond market’s power comes from former Bill Clinton adviser James Carville: “I used to think if there was reincarnation, I wanted to come back as the president or the pope or a .400 baseball hitter. But now I want to come back as the bond market. You can intimidate everybody.”
History is littered with cases of governments that were forced to abandon policies — or that even fell from power — because the bond market revolted. Just a few years ago in the UK, a mass sell-off by currency and bond traders forced the Tory government to abandon its plans for a massive deficit-ballooning tax cut and axe Chancellor of the Exchequer Kwasi Kwarteng, before then-Prime Minister Liz Truss herself was forced to resign after just 45 days in office. Banks like Citigroup were openly declaring that unless the UK got a different prime minister, the markets would continue to punish it. That is power.
Now, Congress is weighing a reconciliation bill that would increase the deficit by at least $3 trillion over 10 years, and possibly closer to $5 trillion if some of its temporary components become permanent, as seems likely. This is a big increase in America’s already substantial debt burden and markets are responding accordingly. Interest rates are heading higher, especially once you adjust for inflation. Countries once infamous for fiscal mismanagement — Greece, Spain, even Italy — can now borrow more cheaply than the United States can.
The US is not the UK; the bond market cannot depose a president the way it can a prime minister, simply because prime ministers are far easier to swap out. But that doesn’t mean that the bond market is powerless over US policy. It has the ability to make this tax bill much, much more costly for the US government and economy, and that ability could be decisive in shaping where the legislation goes from here.
The bond market is mad about the debt
The US issues a lot of different kinds of debt, but the kind you should pay closest attention to are 10-year bonds. These reflect the market’s views on the medium- to long-run trajectory of the government and economy, whereas 30-day or six-month bonds are much shorter-run indicators. The interest rate that’s most informative about government policy and long-run prospects is the “real” rate, adjusted for inflation. If inflation is 4 percent, investors will probably add about 4 percentage points to the real interest rate to make sure their investment doesn’t erode in value. The real rate thus reflects how much they expect to earn for essentially lending money to the US government in addition to just keeping up with overall prices.
Here’s the 10-year, adjusting for inflation, since the start of President Donald Trump’s first term:
In the aftermath of Covid, rates actually went negative after taking inflation into account. This is what’s sometimes called the “flight to safety”: In times of crisis, investors often move away from risky assets like stocks and toward reliable, predictable ones, like US government bonds. That drives interest rates down, sometimes even below inflation.
But since 2023 or so, rates have been much higher. There’s a saying, popularized by economist Scott Sumner, that one should “never reason from a price change”: Changes in the Treasury interest rate (or the price of borrowing) could be from any number of factors, so it’s too simplistic to look at what happened and say “investors decided the US government became a riskier bet.”
That said, when Fed economists analyzed the spike that occurred in 2023, they concluded the spike in rates was indeed due to investors reacting to changing economic conditions: The US was issuing more debt, the Federal Reserve was tightening to try to control inflation, and future economic growth in the US was looking sluggish.
Other observers in the bond market have been sounding alarms, mostly citing excessive US borrowing. In 2023, Fitch, one of the three big credit rating agencies that issues risk evaluations of bonds, downgraded US debt, which previously had a perfect AAA rating. On May 16 of this year, Moody’s, another of the three, followed suit, amid tax cut negotiations in Congress. Standard & Poor’s, the third rater, had already downgraded the US after the 2011 debt ceiling fight, meaning there now isn’t a single rating agency giving US debt top marks.
As the 2023 downgrade indicates, this change isn’t entirely due to Trump. Covid did a number on the US debt picture, with trillions of dollars in relief measures passed and implemented, and many months of lower revenues due to the 2020 recession. But in January, as Trump prepared to return to the White House, bond analysts were already forecasting higher rates, noting his penchant for tax cuts and lack of seriousness about deficits. On May 20, amid the tax fight in Congress, a batch of 20-year government bonds had trouble selling at auction, sending rates flying higher still. The bond market, it is fair to say, is not pleased with the direction this administration is going.
High interest rates could hurt…real bad
The nominal (that is, not adjusted for inflation) 10-year Treasury rate has grown from lows of around 3.6 percent in September to above 4.4 percent now. That, on its own, might not sound like a lot: only a 0.8-point increase?
But if you apply even a small increase in interest costs to the tens of trillions of dollars in debt the US government has outstanding, you get a very big number. Case in point: The Congressional Budget Office, as it evaluates Trump and Republicans’ tax and spending proposals, is assuming 10-year interest rates of 4.1 percent this year, falling to 3.8 percent over time.
What if, instead, rates stayed higher — at 4.4 percent, say? Even that modest-sounding change would cost the US government $1.8 trillion over the next decade, per the Committee for a Responsible Federal Budget; for scale, that’s about what Trump’s more extreme tariff plans are projected to bring in.
A bond market reaction that persistently pushes up rates like this could turn a “merely” $3.1 trillion bill into a $5 trillion bill, raising the price tag by nearly 60 percent, without a single additional dollar in tax cuts or spending. By 2035, the US would be spending $2.1 trillion a year on interest, more than on defense or on Social Security, or on Medicare — some of the biggest portions of the federal budget.
That constrains politicians in both parties quite severely. It makes it harder for Republicans to pass the tax cuts they want, because they now are meaningfully more expensive. Same goes for any deficit-financed spending that Democrats may want.
Some politicians might say, “Who cares? Voters care more about tax cuts than the deficit. Why should it matter to me if some number labeled ‘deficit’ goes up?” It may be true that voters can’t easily parse the difference between a $1 and $2 trillion deficit. But they can definitely tell when things in their daily lives get more expensive, and higher interest costs will make everything more expensive.
Thirty-year mortgage interest rates move in almost perfect tandem with long-term government bonds, as this chart from the Bipartisan Policy Center shows:
This makes sense, if you think about it. When a bank issues a mortgage (or buys one from an issuer), it’s lending money on a long-term basis in exchange for regular interest payments. That’s exactly what an investor does when they buy a long-term government bond. Because mortgage borrowers (that is, homeowners) are typically considered riskier than the US government, they pay somewhat higher rates, but the two rates move together. If the US government starts paying more interest, mortgage borrowers will have to pay more interest too, so that banks lend to them rather than the federal government.
That means that if the bond market sends rates on US debt higher, it’s not just more expensive for the government; it’s more expensive for anyone who borrows. That means homeowners with mortgages, anyone with credit card debt, anyone with a car loan, anyone taking a student loan, and, perhaps most importantly, businesses taking out loans to build factories or invest in research. Good luck getting a US manufacturing renaissance going with persistently high interest rates driven by high deficits.
The odds are still high that Congress passes some kind of deficit-exploding tax bill. The House passed its version by a single vote, and while some Republican senators have voiced complaints, Republicans’ 53-vote majority there means they can afford a few defectors and still pass something. Many of the Trump tax cuts passed in 2017 are set to expire next year, and the political urge to avoid a sudden spike in taxes will probably overwhelm whatever pressure the bond market brings to bear. The bond market is powerful, but Republican hatred of taxes may be more powerful.
But important Republican policymakers are paying attention. House Budget committee chair Jodey Arrington (R-TX) hinted to Politico’s Victoria Guida that he thinks the markets may force more budget cuts than his party is inclined to support, saying, “If the bond markets don’t think we’re serious, I’m not sure it will matter what we do, because they’re going to dictate the terms.”
And senators needed to get the package to the president’s desk are watching too. “Have you been watching what the bond markets are doing in relation to the one big, beautiful bill?” Sen. Ron Johnson (R-WI) asked. “They’re not thinking it’s a very big, beautiful bill.”
Trump’s second term began with him bringing the richest man in the world to DC, with a promise to slash spending, by trillions a year if Elon Musk had his druthers. Now, Musk is leaving DC in a huff, having not meaningfully cut spending at all and by all accounts disillusioned and frustrated at his failure. But Musk is not the last figure who might try to impose austerity on DC, and while he may have hundreds of billions of dollars, the bond market wields tens of trillions. DOGE was, in retrospect, a bad joke. The bond vigilantes’ coming attack may be something much more serious.
