US borrowing outlook steadies after midterms, but Treasury yields face new tests: analysts

The Treasury’s quarterly refunding statement set out its expected borrowing approach. It said note and bond auction sizes would remain unchanged “for the next several quarters.” This matters because auction sizes show how much new government debt the market may need to absorb.

The clearest example was the 30-year bond auction. Treasury kept its size at US$25 billion, matching the May and August refunding rounds. Analysts said this stance was likely to continue, suggesting no immediate increase in long-term debt supply.

The announcement did not eliminate America’s fiscal problems. It indicated that planned Treasury supply would remain broadly stable, while a divided government could limit additional unfunded spending. However, stable auction sizes do not guarantee lower yields. Analysts warned that inflation, energy prices, and financing demands linked to artificial intelligence could still push borrowing costs higher.

A divided government exists when different political parties control important parts of government, such as the presidency and Congress. That split can make new fiscal packages harder to approve. Large programs often require agreement across institutions, so disagreement can slow or block spending plans.

The article’s analysts said a divided government “sharply limits” the scope for future unfunded fiscal packages. Unfunded means spending is not matched by enough new revenue or cuts elsewhere. If such packages are not adopted, the government is less likely to add unexpectedly to its borrowing needs.

This does not solve America’s fiscal challenges. Julius Baer analysts said the election outcome reduced the risk of another discretionary deterioration in the deficit over the next two years. Existing borrowing remains substantial, however, and other pressures, including inflation and energy prices, can still affect Treasury yields.

A budget deficit occurs when government spending exceeds its revenues. The article says the estimated US deficit will remain elevated at around 5.7 per cent of GDP in 2027. GDP measures the size of the economy, so this figure expresses the shortfall relative to national economic output.

The key implication is continued borrowing. When revenues do not cover spending, the Treasury generally finances the gap by issuing government debt. A deficit near 5.7 per cent of GDP therefore points to significant ongoing financing needs, even if auction sizes remain unchanged for several quarters.

The figure also shows why unchanged Treasury supply should not be mistaken for fiscal balance. T. Rowe Price’s Blerina Uruci said the deficit would remain elevated. Analysts expected fiscal policy and Treasury supply to stay broadly constrained, but they still saw other forces, including inflation and AI-related investment demand, influencing yields.

Treasury yields reflect the return investors demand to hold government debt. Restrained borrowing can reduce one source of upward pressure, but it does not control every market force. Persistent inflation or expectations of higher future prices can make investors demand greater returns.

Matthew Ryan of Ebury argued that higher energy prices were driving yields more than fiscal policy. If the Iran war keeps energy prices elevated, investors may expect inflation to remain difficult to control. That can push yields higher, especially on long-dated bonds, whose payments extend far into the future.

The article says long-term yields have risen over the past two years and reached a multi-year high in October. The 10-year yield reached about 5.36 per cent in early October. Even with limited new fiscal packages, yields could remain elevated while energy prices, inflation expectations, and AI investment financing demands persist.

Energy is a major cost across an economy. When energy prices rise, businesses and households can face higher transport, production, and living costs. Investors may then expect inflation to stay elevated. To protect their returns from falling purchasing power, they can demand higher yields on long-term Treasury debt.

The article links this mechanism to the Iran war. Matthew Ryan said yields were being driven more by higher energy prices than by fiscal policy. He added that, as long as the war drags on and inflation expectations remain elevated, yields should stay high. This shows how geopolitical developments can affect government borrowing costs through prices and expectations.

The effect has already appeared in long-term markets. The 10-year Treasury yield climbed to about 5.36 per cent in early October. The 30-year yield later fell to around 5.23 per cent, but analysts still viewed yields as vulnerable to persistent inflation pressures.

The AI investment cycle refers here to spending connected with artificial intelligence, including investment in data centres and related technology. Such spending can support economic activity and create financing needs. Analysts are watching it because its scale may affect both growth expectations and government borrowing markets.

The article highlights overwhelming opposition to data centres across dozens of local ballot measures. Julius Baer analysts said Democratic gains suggested a stronger anti-AI mandate. If companies respond by slowing capital expenditure, businesses would invest less in technology and infrastructure. That could reduce expected economic growth.

A weaker investment outlook could also reduce financing needs. The analysts said any slowdown in capital-expenditure expectations would necessarily lead to a lower growth outlook and more modest issuance needs. This could lessen pressure from future Treasury supply, although the article says the debate over AI investment is likely to intensify in coming months and years.

Treasury bonds are debt issued by the US government to raise money. A bond’s yield is the return investors receive from holding it, usually measured against its price and promised payments. Long-term Treasury yields matter widely because the 10-year note helps set mortgage rates and other borrowing costs.

The price-yield relationship is mechanical. A bond with fixed payments becomes less attractive when new bonds offer higher returns. Its market price must fall until its existing payments produce a competitive yield. Conversely, when demand rises or market yields fall, the bond’s price generally increases. This inverse relationship is standard bond-market mechanics.

The article reports that the 30-year Treasury yield fell to around 5.23 per cent on Wednesday after an early October peak of 5.732 per cent. The decline followed a technology stock sell-off and stronger safe-haven demand. Yet long-term yields remained elevated because inflation, energy prices, and investment expectations continued to matter.