FX.co ★ Fed tightening cycle drives US debt servicing costs up

Key US stock indexes decreased negligibly on Monday. However, it could be the starting point of a new drop amid the ongoing global downward correction. The situation has not changed for the US stock market over the past couple of weeks, and the latest upward movement of indexes was only a correction. Fundamental factors indicate the indexes are likely to slump in the future.

In the meantime, economists are now assessing the costs of the Fed's fight against inflation. As stated earlier, interest rates will be increased until the end of 2022 at the very least, which would boost demand for safe assets such as bank deposits and US Treasury bonds. Furthermore, servicing costs for deposits and Treasuries would increase as well. Commercial banks can cover the extra costs by lending at higher rates, but the US government does not have such a luxury. Higher yields mean higher interest payments for the US. According to the Wall Street Journal, government spending on net interest costs reached $311 billion in October 2021-May 2022, a nearly 30% increase from the same period a year earlier. The yield of 10-year US Treasury bonds has already climbed to 4%, and it could approach 5% if the Fed funds rate reaches 3-3.5%. A 5% yield would make US bonds a very attractive investment. Furthermore, investors would get interest payments at a rate of 5% for the next 10 years, even when inflation returns to the target level of 2%. The US government could issue a bond buyback, but it could only happen if investors are willing to give up their bonds. However, the debt situation does not pose a significant problem for the United States - there are more pressing issues for Joe Biden than the $30 billion US sovereign debt. The Democratic Party could potentially lose its dominance over both the House and the Senate at the upcoming midterm elections in November. A prolonged period of high inflation could make the Biden administration more unpopular among US voters.