Can America afford two wars? Here’s what the bond market thinks

The US bond market can be negatively affected by reminders of the nation's high budget deficit, which was reported to be $1.7 trillion for the fiscal year that ended on September 30. However, if President Joe Biden's canceled federal student debt plan is not taken into account, the deficit could be even higher at around $2 trillion. Budget deficits occur when a government spends more than it collects in taxes, leading to borrowing and the issuance of more bonds, which tends to push bond prices down and yields up. Previously, investors were not concerned about the growing deficit, relying on the Treasury to make interest payments on time. However, there is now increased attention on policies that could further increase the deficit, leading investors to question the sustainability of the debt and demand higher compensation for holding long-term debt. Treasury Secretary Janet Yellen believes that the rise in yields is not primarily connected to the budget deficit but is a reflection of the resilience of the US economy. Lawmakers have yet to approve a budget for the current fiscal year, but the possibility of funding two simultaneous wars in Israel and Ukraine could lead to increased government spending and a higher deficit. However, the impact on the bond market and yields may not be significant, as the proposed defense spending for these wars would only make up a small portion of the deficit. Before the war in Israel, bond yields were already rising due to factors such as inflation remaining above the Federal Reserve's target and the expectation of interest rates remaining higher for longer. The Treasury has also been issuing more bonds since the suspension of the debt ceiling in June. Additionally, Fitch Ratings' downgrade of US debt and Moody's warning of a potential reassessment of the country's credit rating have signaled to investors that holding US debt is riskier. Overall, the uncertainty caused by wars can disrupt markets, making it difficult to predict the future path of bonds.