| WASHINGTON, June 19
WASHINGTON, June 19 If U.S. bond yields continue
their surprisingly steep climb in coming months and years, the
shine will come off a recently brightened budget outlook as
interest costs mount.
The yield on the 10-year U.S. Treasury note jumped to its
highest level in 15 months on Wednesday after Federal Reserve
Chairman Ben Bernanke said the Fed was likely to begin slowing
the pace of its bond purchases later this year. Investors took
this as confirming their fears that a reduction in Fed stimulus
may come sooner than thought.
At 2.35 percent, the 10-year Treasury yield is
now already higher than the level forecast by the Congressional
Budget Office for both the current quarter and the full 2013
average. In early May, that yield was hovering around 1.6
If rates continue to climb at a pace beyond the CBO
forecasts, interest costs over 10 years could rise by hundreds
of billions of dollars a year, said Steve Bell, senior director
at the Bipartisan Policy Center and a former Republican Senate
Budget Committee chief of staff.
"People who are not worrying about the impact of higher
interest rates on the federal deficit are not in touch with
reality," Bell said. "One of the reasons we aren't in worse
shape than we are now is because interest rates are so
The prospect of higher interest costs could quickly reverse
recent optimism over the deficit that was fueled by strong
revenue collections due to a healing economy, accelerated
capital gains realized late last year and big contributions from
government-controlled mortgage funding giants Fannie Mae
and Freddie Mac.
In May, these factors contributed to the non-partisan CBO's
decision to slash forecasts for the 2013 deficit by $203 billion
and for the 10-year deficit by $618 billion. The improvement,
along with a further delay in the deadline for raising the debt
limit to October or November, has largely sapped any urgency
among Congress and the White House to negotiate a new deficit
But should rates stay on their recent trajectory, these
budget gains could be wiped out quickly.
The CBO's "baseline" forecast assumes a slow but steady rise
in 10-year Treasury rates - about a tenth of a percentage point
per quarter, to an average of 4.1 percent for all of 2016.
In late March, Congress' budget referee agency provided an
analysis of how higher rate scenarios would affect deficits.
In one, the CBO took the top 10 estimates from the Blue Chip
survey of economic indicators, which anticipates an average
yield of 2.9 percent in 2014, and 5.6 percent in 2016. It said
this would increase net interest costs by $1.14 trillion, not
taking into account any effects that the higher rates would have
on economic growth.
Another CBO alternative assumes that Treasury yields move
back to their averages in the 1990s, a scenario that would add
$1.44 trillion in interest costs over 10 years.
These added costs would be offset if the higher interest
rates were the result of a strong economy prompting investors to
shift away from Treasuries toward riskier assets such as stocks.
Lou Crandall, chief economist at Wrightson ICAP in Jersey
City, New Jersey, said that since the Fed is unlikely to raise
its short-term benchmark Federal Funds rate any time soon,
short-term Treasury rates should remain relatively low, slowing
the growth in interest costs. The Treasury sells short-term debt
much more often than it auctions longer-term debt.
The CBO interest rate scenarios, including those
incorporated into its baseline forecasts, assume that the
three-month Treasury bill yield will average less than 0.1
percent through 2014. On Wednesday, the three month bill
closed at 0.05 percent.