This romantic-comedy formula is now a mainstay of holiday TV programming: a busy professional from the big city returns home for Christmas and falls for a local fellow after acknowledging her current boyfriend isn’t her genuine soulmate.
According to Martha Gimbel, executive director of the Yale Budget Lab, this narrative could also characterize the bond market’s sentiments toward U.S. debt.
During a Senate hearing this week, she was queried about what could spark a debt crisis and why it hasn’t occurred despite the surge in borrowing in recent years. Gimbel responded that it’s a matter of basic supply and demand, and investors are settling for the easier choice, even if it doesn’t fulfill all their requirements—they just don’t have a superior alternative at present, but that might not always hold true.
“The way I put it is we’re currently the boyfriend at the start of a Hallmark movie in the big city where the girlfriend is still dating him even though she knows it’s wrong,” she elucidated. “But eventually, she’ll go back to the small town and meet the nice firefighter and realize there’s another option.”
For the time being, as Gimbel stated, investors are accepting the status quo, but it won’t be long before we reach a ‘Sleepless in Stagflation’ situation and investors discover better alternatives. Similar to a potential suitor overstating the size of their heart, publicly held debt is quite substantial—it’s already as big as the U.S. GDP and will surpass the all-time record set after World War II in the coming years. Publicly held debt will then keep rising without showing any signs of slowing down as retiring baby boomers push up entitlement spending.
Just like the high-profile professional visiting the small town, Treasury bonds are still in high demand, particularly at present as a safe-haven asset, despite all the unrest caused by President Donald Trump recently. The U.S. debt market remains by far the largest and most liquid, supported by the dollar’s status as the world’s reserve currency.
While Gimbel mentioned she doesn’t know when U.S. debt will lose its appeal, the eurozone has been attempting to make its debt more attractive to investors.
Europe is a top holder of U.S. debt, so any move away from Treasuries could worsen the situation by driving yields up and increasing borrowing costs.
In 2021, Europe initiated the Next Generation EU borrowing program funded through joint debt issuance. Although meant to be a pandemic-era stimulus program, this groundbreaking measure was viewed as enhancing the euro’s status as a reserve asset.
Admittedly, other countries also have safe-haven assets, such as Germany and Scandinavia. But individually, their debt and currency markets aren’t large enough to meet the demands of global finance.
Gimbel noted that investors have recently flocked to Switzerland, adding that the U.S. is fortunate because Swiss financial markets can’t absorb that much capital.
Aided by low debt levels and a reputation as a secure financial hub, Switzerland has long been regarded as a safe haven. That caused the Swiss franc to soar 12.7% against the dollar last year when Trump’s trade war rattled markets. It rose even more this year after Trump threatened to seize Greenland from Denmark.
The war with Iran could deteriorate the U.S. debt outlook as extra military spending increases the deficit, and higher bond yields resulting from oil-fueled inflation translate to higher interest expenses.
“The more we make ourselves less appealing to markets, the more probable it is that you’ll face a fiscal crisis,” Gimbel cautioned. “We’re literally counting on the fact that markets have nowhere else to turn.”