President Donald Trump’s war on Iran is colliding with U.S. debt investors, who demonstrated less appetite for Treasury securities as hopes for a quick end to the conflict evaporate.
This past week, auctions for two-, five- and seven-year Treasury notes all drew weak demand, forcing yields to go higher than expected. That’s a stark contrast from last month, when a Treasury offering saw the highest demand ever in the history of 30-year auctions.
The short end of the yield curve is under extra pressure as soaring oil prices boost the inflation outlook and put additional rate cuts from the Federal Reserve on hold, with odds of a rate hike also increasing.
Meanwhile, the cost of the U.S. war on Iran is worsening the debt picture amid reports the Pentagon is seeking $200 billion from Congress. Not only has the military depleted much of its most expensive munitions that must be replenished, Iranian attacks have damaged or destroyed U.S. aircraft, radar systems, and bases.
“Investors’ concerns include an unsustainable American fiscal position, rising inflation risk and a growing uncertainty about war,” he added, as the 2-year yield topped 4.0% this week, while the 10-year yield shot above 4.4%.
The MOVE index that tracks volatility in the Treasury market has spiked to levels consistent with price instability and policy dysfunction, Brusuelas noted.
If uncertainty continues, it could trigger broader funding stress in debt markets that were already under pressure from worries about private credit, he predicted.
Previous selloffs have reined in presidents, including Trump, who pulled back on his trade war last year after the bond market turned “yippy.” With the U.S. now in an actual shooting war, bond vigilantes could throw their weight around again.
“The need for additional spending to finance the war would increase U.S. debt, sparking a bond market selloff as investors require additional compensation to cover potential losses,” Brusuelas said. “Long-term rates such as 30-year mortgage rates are based in part on the benchmark U.S. 10-year yield. Most important: The bond market remains undefeated.”
That’s as the conflict widens to Iranian allies in Iraq and Yemen, while Persian Gulf neighbors edge closer to taking direct military action against the regime, which is targeting their economic infrastructure.
Thousands of U.S. Marines and paratroopers are also on their way to the Middle East, while the White House reportedly weighs deploying another 10,000 troops for a potential ground assault in Iran to reopen the Strait of Hormuz.
A prolonged war that boosts borrowing costs would come as the federal government must refinance $10 trillion of debt that is coming due in the next 12 months, while the budget deficit is already on pace to hit $2 trillion, according to Apollo Chief Economist Torsten Slok.
