Comment Joost Terks

It was 4:00 pm yesterday — Joost Derks

Interest rates on US government bonds have hit their highest level in more than fifteen years. It is now bullish against the dollar. This tailwind could eventually turn into a headwind, given the high interest costs of the growing national debt.

When it comes to interest rate fluctuations, central bankers have been stealing the show in recent years. Financial markets are holding their breath ahead of new interest rate decisions by the European Central Bank (ECB) and especially the Federal Reserve in the United States. However, the focus this week is not the short-term policy interest rate, but the long-term interest rate determined in the capital markets. There, the yield on US ten-year government bonds briefly rose above 4.8% for the first time since 2007. The rise in interest rates is partly a result of economic factors. Such as avoiding a shutdown in the United States and expectations that inflation will be somewhat higher in the future than the stock market expected.

1,000 billion in government bonds
However, another factor also plays an important role in rising capital market interest rates. The U.S. Treasury may have raised more than $1 trillion by issuing government bonds in the third quarter. That’s a quarter more than at the start of the summer. By the way, this is certainly not an achievement, because during the corona epidemic in 2020, the United States issued almost $3 trillion in new loans. A large supply of government bonds causes bond prices to fall somewhat, which in turn raises interest rates in the capital markets.

Dollar strength continues
Higher interest rates are generally positive for a country’s currency. This applies to both the short-term policy interest rate and the long-term capital market interest rate. US interest rates look set to rise further and remain higher for longer than expected, with the dollar rallying again in recent months. Since mid-July, the currency has risen nearly 7% against the euro. Many parties expect the roles to reverse in 2024, as US interest rates are also expected to fall faster than European interest rates. However, this is not a foregone conclusion when you look at how resilient the US economy is. Also, the dollar often performs well during periods of weak growth in the rest of the world.

Interest payments quickly exceed maintenance costs
However, in the long run, rising capital market interest rates resulting from rapidly increasing national debt do not automatically favor the dollar. Currently that debt is about $33,500 billion or 120% of GDP. The country already spends as much on interest as it does on defense. If the debt burden is high, investors may doubt whether the United States will be able to meet all repayment obligations in the future. Of course, that hasn’t happened yet. But a recent credit rating downgrade from AAA to AA+ by ratings agency Fitch indicates that a big tailwind for the dollar could eventually turn into a headwind.

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Joost Terks

Joost Derks is a currency expert iBanFirst. He has over twenty years of experience in the currency world. This column reflects his personal opinion and does not constitute professional (investment) advice.

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