After Moody's Warning, Federal Officials Continue To Ignore Fiscal Reality

Moody's calculates that interest payments on the national debt will consume over a quarter of federal tax revenue by 2033, up from just 9 percent last year.

Two weeks ago, Treasury Secretary Janet Yellen caused some eyebrows to tilt when she told reporters that rising bond yields were "an important reflection of the stronger economy."

That's contrary to the, let's say, traditional view of how government-issued bonds work.

A bond's yield—that is, the return an investor expects to be paid at the end of the bond's term—is the result of buyers pricing their risk into the purchase. Treasury bonds have historically been some of the most reliable investments out there and, as a result, have typically carried low yields. In other words: Because you can be very confident that the U.S. government will pay you back at the end of the term, you know that your investment is safe, but you also don't stand to make much on the risk.

And while U.S. Treasury bonds remain very safe investments, the traditional view would say that the recent uptick in yields means investors are pricing just a bit more risk into those purchases. For example, the yield on 10-year Treasury bonds—a key benchmark that helps determine the rates of mortgages, student loans, and more—hit a 16-year-high of 5 percent late in October, though it has fallen a bit since then.

In short: Buyers will demand higher yields in order to make riskier investments. That's why the 10-year U.S. Treasury bond yield peaked at 5 percent, while a 10-year Russian bond comes with a yield north of 12 percent. (As an aside, there's something cool and quite libertarian about all this: Governments must answer to the market. It costs the Russian government more to borrow funds simply because investors are less confident that Russia won't stiff them a decade from now.)

So what could be causing investors to price higher risk into U.S. Treasury bonds right now? Yellen says it is the result of a strong economy and the sense that interest rates will remain higher for a longer-than-expected period of time. But that seems to ignore the 300-pound gorilla in the room—or, rather, the $33 trillion mountain of IOUs threatening to bury the Treasury building and the U.S. economy.

It seems more likely that investors are looking at the trajectory of federal budget deficits and the national debt and that they are now hedging their bets, ever so slightly, to account for the possibility of a first-ever federal default.

Moody's, one of the world's "big three" credit rating services, added a significant data point in favor of that conclusion on Friday, when it lowered the federal government's credit outlook from "stable" to "negative."

The change reflects Moody's belief that "downside risks to the nation's fiscal strength have increased 'and may no longer be fully offset by the sovereign's unique credit strengths,'" The Wall Street Journal reported. Moody's calculates that interest payments on the national debt will consume over a quarter of federal tax revenue by 2033, up from just 9 percent last year.

The announcement from Moody's comes just three months after another of the major credit rating services downgraded the federal government's rating from "AAA" to "AA+" in August. The change made Friday by Moody's is not a rating downgrade but signals that one could be coming soon.

Moody's could hardly be more clear in saying how America's mix of political dysfunction and its increasingly unwieldy pile of debt could trigger that future downgrade. "Without effective fiscal policy measures to reduce government spending or increase revenues, Moody's expects that the US's fiscal deficits will remain very large, significantly weakening debt affordability," Moody's said in Friday's announcement. "Continued political polarization within U.S. Congress raises the risk that successive governments will not be able to reach consensus on a fiscal plan to slow the decline in debt affordability."

Yet, in Washington, that announcement was greeted by a chorus of federal officials (and their mouthpieces) denying reality yet again.

White House Press Secretary Karine Jean-Pierre said in a statement that the outlook change from Moody's was "yet another consequence of congressional Republican extremism and dysfunction."

Yellen, on Monday, said she "disagrees" with Moody's decision and claimed the Biden administration is "completely committed to a credible and sustainable fiscal path."

That's despite the fact that the federal budget deficit doubled over the past year. That's despite the White House's request for more spending—which would require more borrowing—in ongoing budget negotiations. And that's despite President Joe Biden's utter unwillingness to engage with the problems facing America's entitlement programs, which are driving much of the unsustainable future deficits.

In Yellen's view, then, increased bond yields do not reflect increasing concern from investors about the fiscal state of the federal government, and growing federal budget deficits are a "sustainable fiscal path." Neither claim makes much sense.

She may turn out to be right, but this comes off as a lot of politically motivated gaslighting. Americans would be wise to keep in mind that the sky is still blue and gravity still pulls you toward the center of the Earth, no matter how many federal officials might claim otherwise.