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The Changing Dynamics of Long-Term Debt Supply

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What impact does the supply of debt have on long-term interest rates? And who controls the supply of long-term debt to the markets?

Long-term rates have been rising sharply in recent months pushing up the borrowing costs for governments, corporations, and for anyone who wants to take out a mortgage.

Graphic: US: Fed Funds, 5Y, 10Y and 30Y Yields

Graphic: US: Fed Funds, 5Y, 10Y and 30Y Yields

Higher inflation and the Fed’s decision to begin raising short-term interest rates are major contributing factors to the rise in long-term borrowing costs.

The supply of debt coming onto the market also influences long-term borrowing costs. During the pandemic, the U.S. budget deficit grew from 5% of GDP to nearly 20%. But during this time long-term bond yields actually fell, in part, because the U.S. Federal Reserve bought $4.8 trillion of debt roughly equivalent to 20% of GDP. So, the U.S. Treasury supplied record amounts of debt but the Fed took the debt back off the market. 

Graphic: Federal Budget Deficit/Surplus as a Percent of GDP

Graphic: Federal Budget Deficit/Surplus as a Percent of GDP

During the past year, the U.S. budget deficit has fallen in half but it remains very large at around 9% of GDP. Meanwhile, the Fed first tapered its borrowing and now plans to sell $95 billion per month back onto the market, putting debt equivalent to about 5% of GDP back onto the market. The net effect may be that even as the budget deficit shrinks, more U.S. Treasury-issued debt finds its way onto the market, possibly putting upward pressure on long-term borrowing costs. 

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