A lot of people are worried about the level of US interest rates. “I think we should be afraid of the bond market,” billionaire investor Ray Dalio said last week. To other observers, the bond market is “barfing,” “signaling a dire scenario for the economy,” “shaking Wall Street,” “sending a warning to Congress,” “giving stock-market investors the yips,” “worrying that something may be breaking beneath the surface” or just plain “breaking.”
I don’t see what all the fuss is about. There is nothing unusual about the current level of interest rates or their recent movement. If anything, this is a yawningly normal interest rate environment.
For perspective, the benchmark 10-year Treasury yield, at 4.5%, is more than a percentage point lower than its historical average of 5.6% since the 1950s (for finance wonks, a negative 0.3 sigma). Even if you remove the period from 1980 to 1985 in which the 10-year yield was persistently above 10%, that historical average declines only modestly to 5.1%, still well above the current yield.
Nor is the recent interest rate volatility all that unusual. Yes, the 10-year yield has bounced around a bunch since the White House’s tariff announcement on April 2. But similar — and always temporary — spikes in volatility were common throughout the 1970s and 1980s and have occurred regularly during every decade since then, including the current one.
So, why all the griping about bond yields? One reason may be that people aren’t used to a normal interest rate environment. The US only recently emerged from an unusually long period of low rates — the 10-year hasn’t topped 5% since before the 2008 financial crisis, even though it was higher than that about half the time since the 1950s.
Also, there’s always something to dislike about interest rates. When rates were at historic lows for more than a decade after the financial crisis, critics complained that cheap debt would encourage risk taking and overinvestment in sectors that rely heavily on borrowing, such as real estate and private equity. They were right. Low interest rates did encourage real estate investment, which, in the case of housing, drove up prices and constrained supply. Low rates also made private equity more lucrative, which allowed PE firms to raise trillions of dollars with which to gobble up broad swaths of the US economy.
A normal interest rate environment should help wring out those distortions. It should also encourage the federal government to reckon with its own excesses. Deficit spending made sense when money was cheap, particularly for investment or to bolster the economy during the Covid pandemic. Now that rates are higher and the economy is growing, policymakers should trim the deficits and shrink the US’s historically high debt relative to gross domestic product.
If they don’t, interest rates could rise to truly concerning levels. The Trump administration is taking two big gambles on rates. One is the budget bill making its way through Congress, which, in its current form, could add as much as $5 trillion in deficits over the next 10 years. The White House is betting that growth will more than offset additional deficits and bring down debt-to-GDP. A second gamble is that tariffs won’t kick up inflation and thereby lift interest rates, either because the threat of higher levies will ultimately result in lower trade barriers or because companies will internalize the cost of tariffs rather than pass them on to consumers.
The bond market will be the judge. If the 10-year yield drifts above its historical average and approaches, say, 7% or 8%, which would still be well within a normal historical range (roughly 1 sigma), that will be a sure sign that the market has lost confidence in Congress’s ability to manage the debt or the White House’s ability to execute a tariff war without stoking inflation.
As things stand, though, interest rates need not interfere with sound fiscal policy. If the US can limit deficits to 3% of GDP, as Treasury Secretary Scott Bessent has pledged to do, debt-to-GDP should drop to 80% by 2050 from closer to 120% today. That assumes nominal GDP growth of 5% a year, comprised of the Federal Reserve’s 2% inflation target and 3% real growth, or some combination of the two.
Interest on the debt as a percentage of the federal budget would also decline significantly, even if rates stay where they are. Assuming an average interest rate of 5% on federal debt, which is well higher than the most recent rate of closer to 3.3%, interest payments as a percentage of the budget would fall to 16% by 2050 from about 26% today. That assumes a total budget of 25% of GDP, roughly the size Congress is currently contemplating.
Still, if the current 10-year Treasury yield seems too high, consider that there are good economic reasons why it has averaged around 5% historically. The base of that rate is inflation, which, if things go according to the Fed’s plan, will run somewhere in the range of 2% to 2.5% long term. The Fed also aims for a short-term interest rate that is about 0.5 to 1 percentage point above the inflation rate, which closely matches the historical average yield on three-month Treasury bills. To lend for longer, investors usually demand a premium, which has averaged 1.6 percentage points for 10-year Treasuries relative to T-bills since the 1980s. The sum of those variables is a 10-year yield in the range of 4% to 5%, precisely where we are today.
The current 10-year yield, in other words, is a sign that the bond market is functioning normally. It may not stay that way given the gathering risks, notably credible estimates that deficits will continue to run well higher than 3% of GDP. But for now, there’s no reason to fear the bond market.
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