SCOTT SIMON, HOST:
Yields on Treasury bonds rose sharply this week. The 30-year note climbed over 5%, the highest level in 19 years. Now, for the government, that means the money it borrows to finance its deficit spending is getting more expensive. For consumers, it could mean higher mortgage rates. And this is not just happening in the U.S. This week, yields for government bonds in Japan reached their highest level ever. In the U.K., they reached a 28-year high. Greg Ip is chief economics commentator at The Wall Street Journal and joins us now. Mr. Ip, thanks so much for being with us.
GREG IP: Thanks for having me, Scott.
SIMON: What's driving the rise of yields in bond markets?
IP: I think there's basically three things that are common to all the countries that are seeing this big rise in long-term interest rates. The first is inflation. We never really completely defeated it after COVID, and now we just got a new dose of it with the rise in energy prices as a result of the war against Iran and the closure of the Strait of Hormuz. The second is government deficits. They're big and getting bigger. Before 2020, we had big deficits, but they're even larger than that now, certainly in the United States, which are the largest we've ever seen outside of wars, recessions or emergencies, but also in Japan in the U.K. and other places. More borrowing by governments and higher inflation are two things that the people who lend money in the bond market really don't like to see.
The third thing I think is the trickiest and that's the whole political culture around the world has tilted towards populism, populism of the left, populism of the right. And essentially, what you see as a result is a complete lack of any will to take the very hard political decisions necessary to bring deficits down. And I think investors are slowly coming to the realization that the things that are bothering them now are going to be around for a very long time.
SIMON: What's the effect likely to be for the average American consumer?
IP: When we look forward, we see a world with higher inflation. That means the Federal Reserve, which controls short-term interest rates but not long-term interest rates, they'll have a lot of difficulty justifying lowering their rates anymore. That alone gives bond investors a reason why they should be pushing yields up higher. And as they do, that will with time result in possibly even higher mortgage rates. And I also think it's harder for the economy and the stock market to continue performing so well when borrowing costs are high. And finally, I think for everybody out there who's a taxpayer, they kind have to worry about the fact that our governments that have borrowed so freely for so long, the bill is coming due.
The debt of this country is now equal to over 100% of GDP. That is virtually without precedent in the postwar era. And as you raise interest on that debt, that money has got to come from somewhere. It starts to squeeze out money that we want for social programs or defense, and it puts pressure on Congress to eventually raise taxes.
SIMON: What about the effect on retirement savings, people who have money in 401(k)s or IRAs?
IP: Well, it's ambiguous. On the one hand, you're like, hey, it's great. I can get more money on my annuities. I can get more money on my bonds. Perhaps, if the Fed raises interest rates, I'll get money on my money market mutual fund. But let's not forget why those rates are going up. One of the reasons is inflation. And so that rise in your income from your bond portfolio, it's partly illusory 'cause it's really just compensating you for the fact that you're paying more for food, more for gasoline, more for cars, more for houses and so on.
SIMON: You've written that deficits in inflation tend to be treated separately, but they may feed each other. Can you tell us more about that?
IP: Sure. Well, so for example, we're getting this inflationary spike from oil, right? So what are governments doing about it? Well, they're not actually tightening their belts. In Japan, they proposed borrowing more money to help protect households from that rise in energy costs. President Trump has talked about suspending the federal gasoline tax. So you have a tendency where these inflationary effects are actually encouraging some governments to talk about borrowing even more. And as governments borrow more, I think bond investors worry that they will be less tolerant of central banks raising interest rates as much as they have to to get control of the inflation problem.
For example, if the Fed does raise interest rates to deal with inflation, that ricochets right back into the federal budget in the form of higher interest on the debt. And so you worry about a situation where leaders, as President Trump himself has said, will pressure the Fed to keep interest rates lower to protect the budget. And in that situation, if the Fed is not allowed to raise interest rates as much as it needs to, then inflation in the future could be even higher.
SIMON: Is there any path you can see to returning to what I'll call an era of low and stable inflation?
IP: I think the number one thing to ensure that we return to low and stable inflation, and therefore moderate interest rates, is the central bank doing its job, which is doing whatever it takes to ensure that in the future, inflation will return to its 2% target. And I have a bit of good news here, Scott, which is that when we look at the way the markets price inflation out there in the future, they actually do think that after two or three years, the Fed will succeed in bringing inflation back to 2%. But, you know, that vote of confidence only means so much. It means that the people who run the Fed, in particular, Kevin Warsh, who has just assumed the Federal Reserve's chairmanship, need to do what it takes to deliver that low inflation. That might mean doing unpopular things like raising interest rates in the short term because although it sounds contradictory, that may be what is necessary to get interest rates lower in the very long term.
SIMON: Greg Ip is chief economics commentator at The Wall Street Journal. Thanks so much.
IP: Thanks for having me.
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