Green Shoots, For Real: Interest Rates Begin Falling Due to Cuts to Federal Spending

And falling interest rates should, in time, result in falling inflation.

Good news via Reason.

Interest Rates Are Falling--Thank Government Spending Cuts for That

Cuts to government spending mean fewer bonds, lower borrowing costs, and potentially a break for borrowers.

The 10-year interest rate has fallen by half a percentage point in the past month--from approximately 4.8 percent to 4.3 percent. Several factors determine interest rates, including inflation and economic growth, but perhaps the most consequential is the supply of and demand for government bonds.

If the Department of Government Efficiency (DOGE) continues at its current pace--which according to its website includes approximately $52 billion in cuts to date--it could possibly cut $1 trillion in spending in its first year. This will mean $1 trillion fewer bonds being issued, reducing the overall bond supply. A lower supply drives the bond price higher, and because bond prices move inversely to interest rates, this will result in materially lower interest rates. This shift is already being reflected in the bond market.

Government borrowing "crowds out" private borrowing--a concept familiar to anyone who has taken a high school economics class. Essentially, the government gets to borrow first, in the form of treasury bonds, and you get to borrow second, in forms such as a mortgage or a car loan. The more the government borrows, the more it pushes up interest rates, which results in higher interest rates on things like homes and automobiles.

If the government hadn't borrowed so much money during and after the COVID-19 pandemic, it's likely that mortgage rates right now would be lower--perhaps significantly lower. The typical 30-year fixed-rate mortgage is about 7 percent at the moment. If mortgage rates were one percent lower, the monthly payment on a $400,000, 30-year mortgage would be about $260 lower. This is the impact the deficit has on your personal finances.

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Had the U.S. maintained a balanced budget over the last decade--or even kept deficits to two or three percent of gross domestic product (GDP)--10-year interest rates would likely be in the 2 percent to 3 percent range. This would mean average mortgage rates would be about 4.5 percent to 5.5 percent. For the first time, DOGE is giving the financial community hope that the deficit might one day return to manageable levels. Interest rates have dropped half a percent in the last month, and it's hard to attribute that to one cause or another, but the buzz is that it's because of DOGE's deficit-cutting efforts.

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The Biden administration's spending policies contributed to inflation and were very bad for the bond market. In his second term, Trump--along with Treasury Secretary Scott Bessent--has placed a stronger emphasis on lowering long-term interest rates. They see the debt as a national security issue, a view shared by economic historian Niall Ferguson who recently proposed what he calls "Ferguson's Law." He says that "any great power that spends more on debt servicing than on defense"--as recently happened in the U.S.--"risks ceasing to be a great power."

More, please, and faster.

posted by Ace at 03:20 PM

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