Let's face it, the U.S. economy has some real vulnerabilities. But it's still the largest economy in the world, and many parts of it are doing just fine.
So, why are some doom-mongers wailing and gnashing their teeth while predicting a collapse in demand for U.S. government bonds? Such an event should bother our readers because it could send mortgage rates shooting higher.
We have some concerns but doubt the likelihood of any such collapse. Barring unforeseen circumstances, we expect that the average rate for a 30-year fixed-rate mortgage will remain below 7%, at least for the next 18 months. That's in line with forecasts from Fannie Mae and the Mortgage Bankers Association (MBA).
Unfortunately, we doubt they'll fall far from their current levels during that time, at least for sustained periods. And that, too, is in line with forecasts from Fannie Mae and the MBA.
However, it's time for us to trot out our favorite quote again, from the late Harvard economist John Kenneth Galbraith: "The only function of economic forecasting is to make astrology look respectable."
What's This Got to Do with Mortgage Rates?
In a newsletter on Monday, The Wall Street Journal drew the link between high yields on long-term U.S. Treasury notes and bonds and high mortgage rates:
"Investors are demanding a higher return to lend to the U.S. government. Several things are behind the recent rise in long-term bond yields, including sticky inflation and a less predictable Federal Reserve. But worries about America’s finances are also a factor. Total public debt outstanding officially passed the $40 trillion mark last week.
"Moves in the bond market influence the price of home loans, which track the 10-year Treasury yield. The rate on a 30-year mortgage has been above 6.6% for most of August."
We should clarify that, while mortgage rates (which are largely determined by yields on a type of bond called a mortgage-backed security) do indeed track the yield on 10-year Treasury notes over time, the relationship is imperfect and the two drift apart sometimes.
The newsletter's headline was "Uncle Sam’s $40 Trillion Tab Is Living Rent-Free in Your Mortgage Payment."
Why Some Gloom Is Justified
In the early hours of Tuesday morning, The Guardian reported that gold prices had reached a three-month high and that Bitcoin had pushed through the $80,000 level for the first time since May. When U.S. Treasury yields are high, these are classic symptoms of a level of panic among investors.
But why are investors spooked? Ipek Ozkardeskaya, senior analyst at Swissquote, gave The Guardian her reasons why gold and cryptocurrencies are suddenly doing so well (we quote):
- A hedge against unclear US fiscal plans and the lack of conviction in the US administration’s capacity to rein in exploding debt when military expenses are adding to already heavy bills.
- A hedge against inflation, amid questions over the Fed’s willingness, or ability, to fight inflation independently.
- A hedge against a potential rout across global risk assets on worries about high valuations, massive AI spending and the growing financing web around the companies involved in building the AI ecosystem – the circularity.
Over the weekend, in his blog, John H. Cochrane, an economist at the Hoover Institution, wrote about the dreaded "bond vigilantes," who bully governments into being more fiscally responsible by refusing to buy their debt (i.e., lend to them) until they are.
"Or, maybe, here come the bond vigilantes," wrote Cochrane. "You knew this was coming, right? Unsustainable fiscal policies can only go on so long. Eventually, bond investors decide that the US will not in the end do the right thing after trying everything else, and default, expropriation, taxation, capital controls, or sharp inflation is on its way." Cochrane goes on to note that in this type of scenario, these bond vigilantes shift their focus from long-term to short-term bonds.
Of course, Cochrane is right about bondholders' concerns. But we believe we're still some way off his scenario.
Why It May Be Too Soon to Panic
Over the weekend, Dr. Noah Smith, another economist, took a different view in a blog post. His headline was, "Are we watching the U.S. go bankrupt? No, but there are still reasons for concern."
Smith acknowledged the concerns outlined by Ozkardeskaya and Cochrane (he even quoted Cochrane), but drew some different conclusions.
Smith noted how small the increase in long-term borrowing costs had been that week, and wrote, "Long-term rates fell in 2019 and bottomed out during the pandemic, then in 2022 and 2023 they had a big sustained rise. In comparison, the rise since early 2026 has been very small — only a few tenths of a percent.
"That could be the beginning of a catastrophic rise, and of course when you’re carrying as much debt as the U.S. government is, even a small increase in borrowing costs can be a headache if it’s sustained over a long period of time."
From there, Smith went on to state that he does not believe the slight rise this year is evidence of a pending bond market collapse. While the national debt remains a valid concern, he argues that this year's modest rise in long-term rates isn't, by itself, much additional cause for alarm.
The United States isn't immune to bond vigilante activities. The Charles Schwab Corp. recalls two events over the last 60 years.
"Although the term bond vigilantes wasn't officially coined until the early 1980s, their influence was already building in the 1970s when stagflation plagued the U.S. economy," says Schwab. "By the end of that decade, amid double-digit annual inflation and persistent federal budget deficits, bond market participants began selling Treasuries." This upward pressure on Treasury yields eventually contributed to the Federal Reserve, then led by Paul Volcker, raising rates considerably.
And Schwab recalls a second instance: "Between the fall of 1993 and late 1994, the 10-year Treasury yield spiked to 8.1% from 5.2%, mainly due to Fed rate hikes but also partly because bond vigilantes sold off their Treasury holdings amid concerns about excessive government spending." In this instance, the Clinton administration responded by implementing measures to reduce the budget deficit. In other words, the actions of the bond vigilantes worked.
America's Economy Still Has Plenty of Strength
So, we can't rely on America's huge economy to provide immunity. But it is worth acknowledging its strength. U.S. gross domestic product (GDP) is projected to top $32.38 trillion this year, according to Worldometers. China, in second place in the league table, is expected to reach $20.85 trillion, while third-place Germany's equivalent figure is $5.45 trillion.
Indeed, add on Japan ($4.38 trillion), and the U.S. economy is bigger than the next three largest economies combined. Meanwhile, the July jobs report put the unemployment rate at 4.1%, which many economists would call full employment.
These impressive data don't negate the real worries many have over inflation, federal debt, and a possible AI bubble. But they are a reminder that, given responsible government policies, there's a good chance the doom-mongers will be proved wrong.
And that would be much better news for mortgage rates than the alternative.
