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.
Pierre Poilievre, the leader of the Conservative Party of Canada, has relentlessly attacked Prime Minister Justin Trudeau's deficits and bloated bureaucracy. Poilievre has managed to translate out-of-control government spending into language everyone can understand—the "crowding out" effect results in higher debt service payments for you.
Poilievre, who would become Canada's next Prime Minister if the Conservatives win a majority government in the upcoming election, was winning on this message for a while. However, when President Donald Trump said that he was going to annex Canada and threatened punishing tariffs, Canadian citizens rediscovered their sense of patriotism, and sentiment has since swung back towards the incumbent Liberal Party. The election now remains a toss-up.
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.
Elon Musk certainly believes as much. "The bond markets do not currently reflect the savings that I'm confident we can achieve," he said during a discussion he led on X. "If you're shorting bonds, I think you're on the wrong side of the bet."
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."
The interest payments on the federal debt are $1.1 trillion and rising—rising in part because much of the debt assumed during the pandemic is still being rolled over into higher interest rates. Trump and Bessent have made it a top priority to get rates down, and DOGE is central to that effort.
Republicans have put the Democrats in a difficult position in that they are arguing against something that should be common sense—cutting government spending—which is never a good position for a political party. The deficit was never going to be reduced by papers and essays. Realistically, it takes someone like Argentina's Javier Milei or Musk—risk-takers who are willing to actually fight the bureaucracy.
For the first time in too long, interest rates are falling due to the real possibility of reduced bond issuance. This is at least one aspect of the Trump administration that should be applauded.
