Buyers of U.S. bonds are getting nervous

• At this point, it isn't a debt crisis or even the kind of mini-crisis that cost U.K. Prime Minister Liz Truss her job in 2022, when the British currency and bonds sold off after an ill-fated budget proposal.
• But there are signs everywhere — in bond market moves, credit rating agency actions, currency markets — that U.S. policymakers have less room to maneuver than they may have thought.

Driving the news: Moody's downgraded the U.S. government's credit rating Friday, the last of the major rating agencies to strip the U.S. of its top-tier status.

• "Successive US administrations and Congress have failed to agree on measures to reverse the trend of large annual fiscal deficits and growing interest costs," Moody's said.
• Treasury bonds were selling off Monday, pushing the 30-year Treasury yield up 0.07 percentage point to 4.97% as of 11:50am ET. It hovered near the highest levels seen since 2007, other than a few days in the fall of 2023.

Between the lines: The Treasury market is perhaps the most scrutinized on Earth, and Moody's analysts don't have special insight that fixed-income strategists and hedge fund managers around the world lack.

• But the fact that bonds sold off following the downgrade suggests global investors who fund U.S. debt are becoming more wary of the long-term fiscal outlook — as reflected in diminished demand for the longest-dated securities.
• Notably, when S&P downgraded the U.S. government's credit rating in 2011, Treasury yields paradoxically fell, reflecting the dominant view then that they represented the ultimate safe haven in times of turmoil.

State of play: Congressional Republicans are making progress on legislation that front-loads tax cuts and backloads spending cuts. Fiscal watchdogs believe it would add trillions to the national debt relative to current law.

• The Yale Budget Lab, for example, calculates it would add $3.4 trillion to cumulative deficits over the next decade if tax cuts expire in 2028 and 2029 as scheduled, or $5 trillion if they are extended.
• The Committee for a Responsible Federal Budget calculates that the legislation could cause the government's debt service costs to approach $2 trillion and more than 4% of GDP, which would be the most on record. (It was 3.1% last year and 1.5% as recently as 2021.)

This represents a turnabout from the pattern of the last 25 years, when there was little evident resistance from bond buyers as the U.S. government looked to borrow.

Zoom out: At other key moments in the recent past when the U.S. considered deficit-enlarging fiscal action, markets gave a big flashing green light.

• That includes the post-2001 global war on terror, the 2008 financial crisis, with President Trump's 2017 tax law, plus the pandemic response under both Trump and former President Biden.
• Now, it is at best a yellow light.

Flashback: Consider the state of play when the 2017 Trump tax cuts were being debated.

• The national debt then was 75.7%. Now it's approaching 100%. The government's debt service costs were 1.4% of GDP. Now it's 3.1% and rising.
• The 10-year Treasury yield averaged 2.3%. Now it's 4.5%.

What they're saying: Russel Matthews with RBC BlueBay Asset Management wrote in a note that "there is limited desire or ability for any US politicians to present a roadmap for a serious reduction in the fiscal deficit.

• "We don't see any contraction in the deficit over the foreseeable future, and the risk is that it increases from the current level around 6.5% of GDP," he added.
• "If this dynamic is unchecked, it is inevitable that the US has some kind of Liz Truss moment; a spike in rates volatility and yields moving substantially higher, particularly at the long end of the curve. However, predicting when we reach this tipping point is extremely difficult," noted Matthews.