Funding debts of this size is pushing up interest rates worldwide. At the same time, bond investors are getting concerned by the high levels of U.S. government debt and the lack of plans to curb spending, so they are demanding higher interest rates on government bonds.
What central banks can do
The Reserve Bank of Australia manages interest rates through the “cash market” — short-term borrowing of less than a day — using the cash rate to influence demand for borrowing. Raising interest rates ultimately dampens economic demand and reduces inflation.
The RBA cash rate affects borrowing costs across the economy for all other forms of debt, including car loans and credit cards as well as mortgages, and corporate debt.
But the RBA can’t directly influence longer-term interest rates such as 10-year bonds, which are market rates and fluctuate constantly based on investor demand.
If the RBA cut rates sharply right now, for instance, bond investors would likely read this as inflationary — pushing up inflation expectations and, in turn, the interest rates demanded on longer-term bonds. The RBA’s action would end up being counterproductive.
America’s ‘exorbitant privilege’ — and its limits
The United States has long enjoyed a unique position in global markets: it can issue growing volumes of government bonds without needing to offer higher rates to attract buyers.
This “exorbitant privilege” stems from the U.S. dollar’s dominance in global trade and financial transactions, and the widespread trust that central banks and private investors place in U.S. government debt.
U.S. Treasury Secretary Scott Bessent has tried to capitalize on this by intervening in the bond market, aiming to shrink supply and push market interest rates lower. That would reduce the interest bill for the U.S. government.
The U.S. Treasury increased the amount of debt it is buying back, but the buybacks only had a brief impact on the market.
Investors concluded the buybacks don’t change the underlying picture: increasing U.S. government financing needs, fears of rising inflation, as well as growing corporate bond issuance to fund AI and data centers. All these forces tend to push interest rates higher over the medium to long term, and no financial engineering can undo this reality.
Rates are rising around the world
Across many countries, bond market rates are rising because higher inflation is eroding the real returns for investors. They are demanding more compensation to protect their spending power.
This is compounded by rising bond issuance from both governments and companies. No amount of financial engineering from the U.S. Treasury can reverse these forces.
Central banks and governments can influence short-term interest rates to some degree. But longer-term debt such as 10-year bonds are ultimately priced on three things:
- Expected inflation
- The scale of government debt and financing needs
- The level of corporate and household borrowing.
The best thing any central bank can do to keep market interest rates low is set policy so inflation remains low.
That’s the purpose of the RBA’s inflation target of 2–3%. As well as keeping a lid on consumer inflation expectations, it lets bond investors know inflation should return to that level in the medium term, and so market interest rates don’t get too high.
This article is republished from The Conversation under a Creative Commons license. Read the original article.
