The Policy Driven U.S. Treasury Yields

Is financial news is constantly throwing curveballs, making it hard to figure out what's really going on? We've been hearing a lot about U.S. Treasury yields skyrocketing, and the usual suspects — budget deficits and big tech's corporate bond issuance — are always trotted out as the culprits. But what if I told you the real story is far more nuanced, and perhaps a bit more concerning. Let’s look into one of the true driver behind these rising yields lies in something far less talked about: regulations impacting pension funds and insurance companies.

Unpacking the "Budget Deficit" Myth

When you hear about rising Treasury yields, the first thing many people point to is the U.S. budget deficit. It makes sense on the surface, right? More government borrowing means more supply of bonds, which should push yields up. But let’s challenges this narrative, suggesting that the data tells a different story. He points out that the U.S. annual budget deficit, when measured against GDP, has actually been shrinking since the COVID-19 pandemic.

Take a look at the chart above. The light blue line, representing the U.S., clearly shows a significant reduction in the deficit compared to the peak during the pandemic. And if you look at Japan, represented by the green line, their fiscal deficit is almost negligible, practically approaching a balanced budget. Yet, both countries are experiencing rising bond yields. This discrepancy suggests that while budget deficits are often an easy target, they might not be the primary driver in this particular scenario. It's almost as if the market wants a simple explanation, and "bad government spending" fits the bill, even if the numbers don't fully support it.

The Overlooked Influence of "Regulations"

So, if it's not the budget deficit, what is it? There is a critical, yet often overlooked, factor: regulations affecting pension funds and insurance companies. These institutional investors are massive players in the long-term bond market, and their ability to buy or sell is heavily influenced by regulatory frameworks. Specifically, he notes that current regulations often prevent them from purchasing long-term bonds when yields are rising.

Think about it this way: when bond yields are falling, these institutions are often compelled to buy more to meet their long-term liabilities, pushing yields down further. But when yields are climbing, the regulations can effectively tie their hands, preventing them from stepping in as buyers. This creates a vacuum in demand, allowing yields to climb unchecked. It's a bit like a game of musical chairs, but when the music stops, the biggest players are forced to sit out, leaving fewer buyers to absorb the available bonds. This dynamic is particularly pronounced in countries with aging populations, like Japan and the UK, where pension and insurance regulations are especially stringent to protect future retirees.

Big Tech's Bond Issuance: A Red Herring?

Another popular explanation for rising long-term yields is the massive corporate bond issuance by big tech companies. The argument goes that these companies are raising huge amounts of capital for investments, creating competition with government bonds and pushing up overall long-term rates. On the surface, this sounds plausible. More demand for capital, more bonds in the market, higher yields.

However, this explanation also misses a crucial step in the economic chain. For big tech's bond issuance to truly drive up overall long-term yields, it would need to translate into a significant increase in aggregate economic growth and inflation. If big tech's investments were genuinely boosting the entire economy, then global investment banks (IBs) would be revising up their growth and inflation forecasts for the U.S. But they're not.

What's likely happening is a "crowding out" effect. While big tech might be investing heavily, these investments might be displacing or reducing investment in other sectors of the economy. So, while one part of the economy is booming, other parts are contracting, leading to a net neutral or even negative impact on overall growth. It's like pouring water into one bucket while simultaneously draining another – the total amount of water doesn't necessarily increase. Therefore, simply looking at big tech's bond issuance in isolation can lead to a misinterpretation of its broader impact on interest rates.

The "Diffusion" of Inflation and the Core CPI

Beyond bond yields, the conversation often turns to inflation. We hear about rising oil prices or tariffs, and the immediate reaction is "inflation!" There is a vital distinction: inflation isn't just about a single price going up; it's about the diffusion of that price increase across other sectors of the economy. If oil prices rise but don't cause a ripple effect of price increases in other goods and services, then it's not true inflation in the broader sense.

This is why there is an emphasis on looking at the Core CPI and the Trimmed Mean CPI. The Core CPI excludes volatile items like food and energy, giving a clearer picture of underlying price pressures. The Trimmed Mean CPI goes a step further, removing the most extreme price changes (both up and down) to focus on the central tendency of inflation. Interestingly, he notes that both these measures have shown a downward trend, or at least a lack of significant upward pressure, even as headline figures might fluctuate due to oil prices. This suggests that the broader inflationary pressures might be more contained than many believe, challenging the narrative that every price hike automatically signals widespread inflation.

What Does This Mean for You?

Understanding these underlying dynamics is crucial for making informed financial decisions. If the primary driver of long-term yields isn't budget deficits or big tech's bond issuance, but rather regulatory constraints on major institutional investors, it changes how we should think about the future trajectory of interest rates. It suggests that these yields might be less responsive to traditional economic indicators and more susceptible to policy changes or shifts in the regulatory landscape.

For investors, this means looking beyond the headlines and conventional wisdom. It encourages a deeper dive into the structural factors at play, especially the often-invisible hand of regulation. While the market might continue to attribute rising yields to more familiar causes, recognizing the role of "policies” and “regulations" can provide a more accurate and potentially more profitable perspective on where things are truly headed. It's a reminder that in finance, as in life, the most obvious answer isn't always the correct one.