Professor/Lecturer Ellmann's Course Materials Page

nervous bonds' power
Home
microeconomics
FREEDOM
macroeconomics
economic thought
MBA/MA - Anglo-American University International Finance
ERASMUS - International Finance
MBA - Money and Financial Markets
ERASMUS Money & Banking
M.A. Public Policy Economic Sociology
Ethics
On the Origin of Facts

Jittery Bond Market Threatens President's Agenda

WASHINGTON -- Senior Obama administration officials said Friday that policy adjustments necessary to contain soaring budget deficits would be made once an economic recovery takes hold, in response to growing concerns about a run-up in long-term interest rates.

Treasury Secretary Timothy Geithner, National Economic Council chief Lawrence Summers and Office of Management and Budget director Peter Orszag said in separate interviews that the administration was acutely aware that rising interest rates pose a threat to the improving U.S. economy.

[chart]

Yields on 10-year Treasury notes have risen 1.5 percentage points this year as bond traders pull back amid worries about rising federal debt. Higher yields will leave the government with higher interest costs and still higher deficits. They could also push up other forms of interest rates, making borrowing more expensive for many people.

On Thursday, the Treasury Department is expected to announce an auction of roughly $65 billion in three-year, 10-year and 30-year notes and bonds, and the result will be closely watched.

"We're going to do what's necessary," Mr. Geithner said. "That's the only way you're going to get a strong, sustainable recovery." As soon as a recovery takes hold, the administration will reduce the deficit to a sustainable level, he said, adding, "That's difficult, but critically important."

Mr. Orszag said the administration's commitment to fiscal rectitude would become clear in coming weeks when President Barack Obama demands that any health-care plan drafted in Congress be fully paid for. That pledge, he said, "is ironclad, no ambiguity, not up for negotiation."

Additional steps on the deficit may become necessary, he added, and the administration is committed to turning to Social Security next.

"There is not a day that goes by that the president and the economic team do not focus on the long-term commitment to decrease the deficit," Mr. Summers said.

The comments by the administration officials were aimed at calming worries on Wall Street, and indicated concern that rising interest rates might imperil the president's domestic agenda, as they have done to the plans of previous Democratic administrations.

Some officials tried to play down market fears about federal borrowing. The jump in long-term interest rates, both in Treasurys and mortgages, is more a product of technical factors, they argue, than a reaction to Washington's borrowing.

Another possible cause is the improving economy. Investors who sought safe harbor in Treasurys are now selling U.S. debt and looking for higher returns.

The emerging scenario harks back to the early Clinton White House, when the bond market helped scuttle a stimulus package and forced a focus on deficit reduction.

Senior Obama administration officials said the current situation isn't parallel. The recovery isn't as established and business investment isn't being held back by interest rates, they said. But they acknowledged history could repeat itself.

"Clearly, the message from the bond market increasingly is [that] structural deficits as far as the eye can see just aren't going to wash without bond yields going up to levels that might keep us in recession," said Ed Yardeni of Yardeni Research Inc.

In March, debt-laden Britain had its first failed debt auction since 1995, and the worst auction in British history, when a sale of £1.75 billion (about $2.8 billion) of 30-year notes attracted just £1.67 billion in bids. Last week, Standard & Poor's warned that Britain could lose its triple-A credit rating if large deficits persist.

The nonpartisan Congressional Budget Office estimated that Mr. Obama's budget would leave the deficit above $1 trillion in 2019. Goldman Sachs projected borrowing of $3.25 trillion this fiscal year and a national-debt load of 83% of gross domestic product by the end of the decade -- double the current debt-to-GDP ratio.

The CBO projected the White House plan would cut in half the deficit inherited from the administration of former President George W. Bush by 2012, as Mr. Obama promised, but would still leave $658 billion of red ink.

Those numbers rely on some rosy assumptions, including inflation-adjusted economic growth of 3.2% next year and a 2009 unemployment rate of 8.1%. The rate hit 8.9% in April.

The Obama forecast anticipates a national health-care plan that could cost well over $1 trillion in its first decade, paid for by tax increases and spending cuts and a climate-change plan that would bring in $646 billion.

"As far as I can tell, their fiscal plan is spending more on health care and hoping somehow that will make us pay less for health care," said Phillip Swagel, a former assistant secretary of the Treasury for economic policy in the Bush administration. "That's the intellectual counterpart of tax cuts pay for themselves."

Obama administration officials acknowledge the interest-rate increases this week have raised pressure to get a deal fast on health-care legislation that emphasizes cost containment.

Mr. Orszag posted a message on his blog Friday explaining how a surge in health-care spending now will help lower deficits in the long run.

Many are skeptical. "Their talk of a return to fiscal discipline has not really resonated on Wall Street," said Milton Ezrati, a partner and market strategist at Lord Abbett & Co., a money-management firm.

Lou Crandall, chief economist at Wrightson ICAP, a Wall Street research firm that specializes in Treasury financing, said short-term spending is necessary, but added, "it would be great for the market to know there is an exit strategy."

Write to Jonathan Weisman at jonathan.weisman@wsj.com

Enter supporting content here