Latest / The National Debt Podcast with Fexingo: Treasury, Borrowing, and Long-Term Fiscal Outlook / How Tariffs Are Rewiring Federal Borrowing Costs
Transcript
- Lucas: The number sitting on our screens right now for total federal debt is thirty-nine point four six trillion dollars. It’s a figure that feels abstract until you look at the interest payments attached to it, and lately, those payments are moving faster than the principal itself. We usually talk about the size of the hole, but today I want to talk about why the cost of digging it just got steeper. Luna: Right, because the yield on the ten-year Treasury just ticked up to five point two eight percent, which means every new dollar borrowed is costing the government significantly more than it did last quarter. It’s not just about volume anymore; it’s about the price tag on that volume. Lucas: Exactly. And here is the specific angle I want to drill into: the New York Fed recently pointed out that much of the recent inflation spike wasn't organic demand, but entirely driven by tariffs. When you tax imports, you aren't just raising revenue; you are effectively taxing the domestic supply chain, and that gets baked into the consumer price index. If prices go up because of policy, the Federal Reserve has to keep rates higher for longer to fight that residual heat. Luna: So you’re saying the tariffs are creating a feedback loop where the Treasury has to issue more debt at higher yields because the central bank can’t cut rates fast enough? That seems like a direct threat to fiscal stability. Lucas: It is, and it creates a weird dynamic where the government is simultaneously trying to manage trade policy and struggling with the monetary consequences of that same policy. Let me pause here for a second though, because if walking through these mechanics has made something click for you, the way these stay ad-free is listener support — buy me a coffee dot com slash fexingo. It keeps the research sharp and the ads off your feed. Luna: Yeah, totally agree. It’s worth backing the work that makes sense of this noise. So, getting back to that loop, how does this actually hit the average investor holding bonds? Lucas: It hits them through duration risk and real yield compression. Look at the spread between the two-year and the ten-year. It’s sitting at fifty-one basis points, which is positive, meaning the curve is still upward sloping, but it’s flattening out compared to where it was earlier this year. Investors are demanding a premium for locking their money away for a decade because they know inflation could spike again if trade wars escalate. Luna: But isn't the twenty-four month Treasury yield actually lower, at four point seven seven percent? Doesn't that suggest the market thinks the Fed might be done hiking? Lucas: That’s the short end talking. The short end reflects the current Fed Funds effective rate, which is around three point seven five percent, and the expectation that they’ll hold steady or cut slightly. But the ten-year is priced for the next decade, not the next six months. The market is telling us it doesn't trust that inflation will stay dead, especially with those tariff-induced price shocks lingering in the background. Luna: So the disconnect is between what the Fed controls in the short term and what the Treasury is forced to borrow against in the long term. That feels like a vulnerability. Lucas: It is a vulnerability, specifically for holders of long-duration assets. When you look at the thirty-year Treasury yield, it’s at five point six seven percent. That is a historic level for safe government debt. You have to ask yourself: who is buying this? Is it foreign central banks, or is it domestic pension funds locking in yields before they drop further? Luna: I’d guess it’s mostly domestic institutional money. Foreign buyers seem hesitant given the currency risk and the political uncertainty around trade policy. They don’t want to lend to a country that might weaponize its own currency via inflation. Lucas: Precisely. And that brings us to the deficit number. For the most recent period ending in September, the federal deficit was negative one point seven seven trillion dollars. That’s a massive cash burn. Now, combine that burn with the fact that the interest rate on that new borrowing is structurally higher due to tariff-driven inflation expectations, and you get a compounding effect that is hard to reverse without severe austerity. Luna: Austerity is politically impossible, so we’re left with financial repression or letting inflation eat the debt. Which one do you think the Treasury is betting on? Lucas: They are betting on financial repression, subtly. By keeping the yield curve controlled, they ensure that domestic institutions like banks and insurers are forced to absorb the debt. But tariffs disrupt that control because they introduce external volatility. The IMF chief recently mentioned AI as both a hope and a hazard, but she didn’t mention that tariffs are a hazard to the very fiscal space governments need to invest in that technology. Luna: That’s a good point. If the government is borrowing heavily to service old debt at high rates, there’s less room to spend on innovation or infrastructure. It’s a crowding-out effect, but worse, because the borrowing is involuntary. Lucas: It’s involuntary crowding out. And notice how the twelve-month inflation outlook in the Fed survey just hit its highest level since May twenty-twenty-three. That’s not a lagging indicator anymore; that’s forward-looking fear. When investors see that survey data, they don’t just adjust their portfolios; they start pricing in a higher probability of fiscal dominance. Luna: Fiscal dominance means the central bank loses independence because it has to prioritize keeping government borrowing costs manageable over fighting inflation. Is that really happening here, or is it just a theoretical risk? Lucas: We’re seeing the early stages of it. The FOMC is stuck between a rock and a hard place. If they cut rates too aggressively to help the Treasury with debt servicing, they let the tariff-driven inflation run wild. If they keep rates high, the cost of rolling over that thirty-nine trillion dollars becomes unsustainable for the budget. It’s a lose-lose scenario for policymakers. Luna: So the bond vigilantes aren't exactly revolting; they’re just quietly refusing to subsidize the gap between tariff costs and budget reality. They want the full yield. Lucas: Spot on. And look at the VIX. It’s been relatively calm, which suggests the market hasn’t panicked yet. But panic isn't always loud. Sometimes it’s just a slow grind up in the ten-year yield, from five point two percent to five point three, then five point four. Each basis point adds billions to the annual interest expense. Luna: Let’s put some numbers on that. If the ten-year yield moves up another twenty-five basis points, that’s an extra hundred billion dollars or so in annual interest costs on the outstanding debt, right? Lucas: Roughly. And that’s assuming the stock of debt stays flat, which it won’t. The deficit is expanding, so you’re adding new principal at a higher rate while paying more on the old principal. It’s arithmetic cruelty. The debt to gdp ratio is already at one hundred twenty-two point six percent. Adding interest expenses without growing GDP sufficiently turns that ratio into a gravity well. Luna: And GDP growth is slowing down precisely because those tariffs are acting as a tax on consumption. So we have slower numerator growth and faster denominator growth in the debt ratio. That’s the definition of a fiscal spiral. Lucas: Yes, and the international comparison is stark. India’s central bank just hiked rates for the first time since twenty-twenty-three because their inflation risks are building. Meanwhile, the US is trying to navigate this tariff shock. Global capital flows are shifting. Money is moving out of risky emerging markets and into... well, it’s hesitating to move fully into US long bonds because of the fiscal uncertainty we just discussed. Luna: So where does that capital go? Does it sit in cash? Does it go into gold? Or does it stay in shorter-term Treasuries and avoid the long end entirely? Lucas: It’s staying short. Look at the three-month Treasury yield; it’s at four point two two percent, tracking the Fed Funds closely. Investors are refusing to lock in for ten or thirty years because the inflation risk is too binary. Either tariffs ease and inflation drops, or tariffs stick and inflation persists. Until that clarity arrives, the long end is expensive for a reason. Luna: It’s a wait and see market. But waiting is expensive when you’re the government issuing debt. How does this change the strategy for someone managing a private portfolio right now? Lucas: For individuals, it means diversifying away from pure long-duration fixed income exposure unless you’re hedging with inflation-protected securities. TIPS become attractive not because they offer high nominal yield, but because they protect against the specific risk we’re talking about: tariff-driven CPI spikes. If prices rise due to import taxes, TIPS adjust the principal upward. Luna: That makes sense. So instead of chasing the five percent yield on a ten-year nominal bond, you accept a lower nominal yield on a TIPS because you’re guaranteed the real return if inflation runs hot. It’s a hedge against policy error. Lucas: Exactly. It’s a bet that the Treasury will misprice the risk of its own trade policies. And honestly, looking at the ICE data showing weakened economies in certain sectors, the structural damage is already visible. The question is whether the market has fully priced in the fiscal consequence of that damage. Luna: I doubt it. Most people are still focused on earnings reports and tech valuations. The macro backdrop of rising debt service costs is too boring for the headlines, even though it’s the most important variable in the room. Lucas: It’s boring until it’s not. When the interest payment exceeds the defense budget or the education budget, suddenly everyone pays attention. We aren't there yet, but the trajectory is clear. Thirty-nine point five trillion is a milestone, but thirty-nine point six trillion with a higher yield is the real danger zone. Luna: So the takeaway is that the cost of capital is no longer just a monetary policy variable; it’s a fiscal policy variable too. Trade decisions directly impact bond yields. Lucas: Correct. And if you’re listening to this thinking that the government will simply print its way out of it, remember that printing devalues the currency, which makes imports more expensive, which raises inflation further, which pushes yields even higher. It’s a closed loop. The only escape hatch is growth, and tariffs make growth harder. Luna: A self-reinforcing cycle of higher costs and slower growth. It’s a tough spot for any economy, but especially one with debt levels this high. Thanks for breaking down the mechanics, Lucas. Lucas: Thanks, Luna. The real question for next week is whether the Fed acknowledges this tariff-inflation link in their minutes, or if they pretend it’s transitory. Watch for that language, because it signals their true stance on the debt.