After Trump announced “Liberation Day” on 2 April, US government bond yields began to rise – and even after the announcement on 9 April of a “pause” in the implementation of Trump’s massive tariff increases, yields continued to climb.
It was especially the 30-year Treasury yields that rose to alarmingly high levels, reaching just above 5% by the end of May.
However, in June, things seemed to calm down somewhat – partly because the economic data turned out slightly better than expected, keeping the door open for further interest rate cuts from the Federal Reserve.
Now, though, we are once again approaching the 5% mark on the 30-year US yield, after several weeks during which long-term interest rates have ticked upwards – not only in the US, but also in Japan, the Eurozone, and the UK.
So far, the equity markets have largely ignored the renewed rise in yields, but I firmly believe there’s good reason to keep a close eye on interest rates. Given that Trump and US politicians seem unwilling to take the country’s enormous fiscal challenges seriously, there is every reason to believe that we may be heading for a fresh wave of market turmoil. This could trigger a drop in US stock prices, a further weakening of the dollar – and yes, we might well see the 30-year Treasury yield rise above 5% again within the next few days.
The question is whether calm can be restored as easily as it was in May–June, or whether we’re in for a much rougher ride this time.
And yes, Trump’s tariff circus is also playing a role again – we are, as I’ve noted in recent days, effectively heading towards 1 August, when tariff levels could return to those originally announced on Liberation Day.
The Unpleasant Arithmetic Returns
Regular readers will recall my May post “The US Consumer Goes to Fiscal Reality Mart: Tariffs or VAT?” about what I’ve termed the “unpleasant arithmetic.” With US federal debt held by the public now at 100% of GDP, the United States has crossed a critical threshold where traditional monetary policy tools become dangerously constrained. The maths are brutally simple: with total US federal debt at $36 trillion, each percentage point rise in rates adds approximately $360 billion to annual interest costs.
This creates what economists call “fiscal dominance” – a situation where monetary policy becomes subservient to fiscal needs. When the US Court of International Trade struck down Trump’s Liberation Day tariff programme in April, they didn’t just deliver a legal judgement; they exposed the fundamental fiscal constraints facing the US administration.
As I wrote then, once you breach the 7-8% threshold on government borrowing costs, you enter an explosive feedback loop. Higher rates generate larger deficits, which require more debt issuance, which pushes up term premiums, which drives rates even higher. It’s a self-reinforcing spiral that, at 119% debt-to-GDP, becomes mathematically impossible to escape through conventional means.
Why This Time Is Different
Back in 2013, I argued in “Be right for the right reasons” that 5% yields on the 30-year US Treasury would signal the end of the Great Recession and a return to the nominal GDP growth rates of the Great Moderation. But context, as they say, is everything. Then, 5% yields meant healthy growth expectations; now, they signal something far more ominous – the stirring of the bond vigilantes.
The temporary calm in June shouldn’t fool anyone. Yes, US inflation expectations dipped from 6.6% to 5.1% according to the Michigan survey, and yes, some economic data surprised to the upside. But these are merely ripples on the surface whilst the underlying currents grow stronger.
Consider the global nature of the current yield surge. It’s not just US Treasuries – Japanese, European, and UK yields are all rising in tandem. This isn’t a story about relative growth differentials or monetary policy divergence. It’s about a fundamental reassessment of sovereign credit risk in an era of fiscal profligacy.
The August Deadline Looms
US Treasury Secretary Bessent’s announcement that tariffs will “boomerang back” to Liberation Day levels by 1 August for countries without trade deals represents more than diplomatic brinkmanship. It’s an acknowledgement of fiscal desperation dressed up as trade policy.
As I demonstrated in “The US Consumer Goes to Fiscal Reality Mart: Tariffs or VAT?”, even revenue-maximising tariffs at 33% would generate only 2.3% of GDP whilst creating deadweight losses of 1.14% of GDP. For every dollar collected, the economy loses an additional 49 cents. It’s fiscal madness masquerading as “America First” economics.
The court’s April ruling was clear: the US president cannot simply declare economic emergencies to impose tariffs at will. Yet here we are, three months later, with the administration attempting to achieve through negotiation what it couldn’t accomplish through executive fiat. The markets aren’t impressed, and neither should they be.
What the Markets Are Telling Us
The renewed talk about Trump potentially firing Powell is particularly troubling. Over the weekend, National Economic Council Director Kevin Hassett said the administration is “looking into” whether Trump has the authority to fire the Fed Chair, suggesting the $2.5 billion renovation of Fed headquarters could provide “cause.” This comes as Trump faces mounting pressure from his MAGA base over the Epstein files debacle, with many calling for Attorney General Bondi’s resignation.
When US presidents face political heat, they often create diversions. And with Trump defending Bondi while his base revolts – the first major split we’ve seen in the MAGA movement – firing Powell would certainly change the subject. It would also be catastrophically stupid from an economic perspective.
Through the lens of MV = PY, such a move could trigger the velocity shock I’ve been warning about. When central bank independence is questioned, households and businesses reduce their money holdings. Velocity accelerates, creating inflation without any increase in the money supply. It’s the mirror image of 2008, when velocity collapsed and the Federal Reserve struggled to prevent deflation.
The Fed now faces an impossible trilemma: they can’t simultaneously maintain price stability, fiscal sustainability, and financial stability. Something has to give. Powell’s recent comments about “staying the course” on inflation ring hollow when everyone knows that above 7-8% rates, the US fiscal arithmetic explodes.
This is why US equity markets’ current complacency strikes me as dangerously misguided. They’re pricing in a Goldilocks scenario where the Fed defeats inflation without triggering a fiscal crisis. The bond market, always the adult in the room, is telling a different story. And now we have the added risk of Trump doing something monumentally foolish to distract from his domestic political troubles.
What Happens Next
The risk I highlighted in May remains very real and is growing: the US could face a multi-phase crisis where rising term premiums lead to capital flight, forcing Fed intervention that sparks surging inflation and ultimately results in de facto debt restructuring. The probability of this scenario is increasing.
The approach to 5% on the 30-year US Treasury yield is the canary in the coal mine. Cross that threshold decisively, and we enter the danger zone where fiscal mathematics overwhelm monetary policy. The June respite bought time, nothing more. Unless US politicians suddenly discover fiscal religion – and Trump’s weekend theatrics defending Bondi whilst his own base calls for her resignation suggests otherwise – the unpleasant arithmetic will assert itself.
For investors, the message is clear: don’t mistake temporary calm for permanent resolution. The bond vigilantes are stirring, and they have mathematics on their side. When US sovereign debt reaches 100% of GDP, 5% long-term rates aren’t a sign of healthy growth expectations; they’re a warning that the game is nearly up.
As I’ve said before, whilst politicians debate, mathematics calculates. And right now, the sums are looking increasingly brutal. The question isn’t whether we’ll see fresh market turmoil, but when – and whether this time, the traditional policy tools will be enough to restore calm.
I suspect we’ll have our answer soon enough. The 1 August tariff deadline may prove to be about more than trade policy. It might just be the date when fiscal reality finally trumps political rhetoric.
