The Congressional Budget Office has issued a warning regarding the risks of a bond market crisis in the United States, similar to the one that occurred in the United Kingdom 18 months ago. US government debt has reached nearly $35 trillion and is on an unprecedented trajectory, raising concerns about the impact on the economy and America’s credit rating. The fear is that higher interest rates could lead to a sharp increase in the cost of paying creditors, potentially causing bond markets to snap back.
The UK’s bond market crisis in 2022 serves as a cautionary tale of the consequences when investors reject a government’s plan to borrow more. There was a significant sell-off of UK government bonds and the pound in response to plans to issue more debt to pay for tax cuts. Mortgage rates and borrowing costs soared as investors demanded higher premiums for owning UK debt. The Bank of England had to intervene by buying gilts on a large scale to stabilize the market and prevent risks to financial stability.
US government debt has been increasing under both Republican and Democratic administrations, driven by factors such as tax cuts by former President Donald Trump in 2017 and pandemic-related stimulus under President Joe Biden. Economists have long warned about the dangerously high levels of debt, with Fitch downgrading the US credit rating due to the growing government debt burden. If Trump is re-elected, he has promised to extend tax cuts and reduce the corporate tax rate, potentially leading to more borrowing.
In the UK, tax reductions planned by former Prime Minister Liz Truss included the biggest cuts in 50 years, such as reducing the top rate of income tax from 45% to 40%. The increased cost of servicing debt in the US, coupled with a rapid rise in official interest rates, is diverting significant amounts of money away from public services. Interest costs in fiscal year 2023 were $659 billion, up 39% from the previous year and nearly double what it was in fiscal year 2020. This has led to concerns about the impact on economic growth and the fiscal outlook.
The CBO warns that US government debt is projected to continue rising, potentially slowing down economic growth, increasing interest payments to foreign holders of US debt, and limiting policy choices for lawmakers. The report highlights the significant risks posed by a large and growing debt burden, emphasizing the need for policymakers to take action to address the situation. The trajectory of US government debt, coupled with rising interest rates and servicing costs, underscores the importance of implementing sound fiscal policies to prevent a bond market crisis and ensure financial stability.
