Canadian Prime Minister Mark Carney stirred the financial world over the weekend with a pointed comment about the United States, saying that “markets sometimes ignore fundamentals, then suddenly they pay close attention. And when they pay attention, if you haven’t put your house in order, it’s too late. We have put our house in order.” The remarks, made against the backdrop of rising long-term interest rates and persistent fiscal imbalances in the US, have reinvigorated debate about the sustainability of American public finances.

Carney, a former central banker who led the Bank of Canada during the 2008 financial crisis and later the Bank of England, has a reputation for blunt assessments. His comments come as the US Treasury faces growing pressure from bond investors demanding higher yields to compensate for inflation and heavy debt issuance. But what exactly did Carney mean, and why should global markets care? To answer that, one must examine the current state of US fiscal policy, the mechanics of bond markets, and the wider implications for the global economy.

What Is Mark Carney Referring To?

At its core, Carney’s statement refers to the fact that the fiscal situation in the United States, at least on the surface, appears worse than in Canada. “There is a fiscal deficit in the United States that is deteriorating,” said economist Jocelyn Paquet of National Bank. “The US spent a lot during the pandemic to cushion the shock and has been running large deficits since. The deficit is on track to approach 6% of GDP this year. That is unprecedented outside a recession in the United States.”

The magnitude of that deficit is striking. Historically, the US has seen deficits of 6% or more only during deep economic downturns when tax revenues collapse and automatic stabilizers kick in. In times of economic expansion, deficits have typically narrowed to between 2% and 4% of GDP. Today, with unemployment low and growth still positive, the US is running a structural deficit that shows no sign of shrinking. This is a serious concern for fiscal sustainability, as debt levels continue to climb relative to the size of the economy.

“Is public finance sustainable? In the United States, the answer is no. It’s clear to everyone,” said strategist Sébastien McMahon of iA Financial Group. “But where is the debt ceiling? No one knows. The situation appears precarious with the deficits. It’s a concern for markets. But we have been worried about this situation for more than a decade.”

Why Is This a Point of Vulnerability for the US?

The combination of high debt levels and higher interest rates means that the US government now pays significantly more interest on its obligations than before the pandemic. When investors buy government bonds, they are effectively lending money to the government. If they begin to doubt the government’s ability to repay, they will demand even higher yields, creating a vicious cycle that can quickly spiral out of control.

“If bond investors come to think that the government will not be able to repay its debts and that there is a risk of default, at some point interest rates will rise a lot, which can be tragic for a government, as we saw in the United Kingdom a few years ago,” said McMahon. But before that happens in the US, he noted, American policymakers could raise taxes or cut spending programs to restore confidence.

That said, there is a higher tolerance among investors toward the US for fiscal misbehavior because the dollar is considered a safe haven, added Paquet. The dollar’s status as the world’s primary reserve currency allows the US to borrow at lower costs than most countries, but it is not a free pass. Investors have limits, and those limits become visible when yields start to rise sharply.

Why Are Long-Term Bond Yields Rising?

Long-term bond yields are not set by any single actor; they reflect the collective judgment of millions of investors worldwide. According to Jocelyn Paquet, there are three main reasons behind the current upward movement in yields.

First, inflation expectations. “There is more inflation. If you are an investor, you ask to be compensated more. If you are assured a return of 2% for the next 10 years and inflation is at 1.5%, you can be satisfied. If inflation is above target, as is the case in the US for several years, you will ask for more to protect yourself against inflation,” Paquet explained. Even if inflation has moderated from its post-pandemic peaks, it remains above the Federal Reserve’s 2% target, forcing investors to demand higher term premiums.

Second, the supply of bonds. “Governments are spending more than before the pandemic, which translates into a larger supply of bonds. One can therefore expect bond prices to fall and, consequently, yields to rise,” Paquet said. The US Treasury has been issuing debt at a rapid pace to finance deficits, and this increased supply puts downward pressure on prices, pushing yields up.

Third, the artificial intelligence investment boom. “Companies are investing massively and need to finance themselves, which increases the supply of corporate bonds that sometimes compete with sovereign bonds. That puts pressure on the entire bond complex,” Paquet added. Tech giants and other firms are borrowing heavily to build data centers and AI infrastructure, adding to the overall demand for capital in an already tight market.

Could Foreign Holders of US Debt Sell Massively?

Canada, like Japan, China, and the UK, is a major creditor of the United States. But the idea that these countries could suddenly dump their holdings and damage the US is largely a myth, according to experts.

First, it is important to understand who actually holds US debt abroad. When we say Canada holds US bonds, for example, this refers to Canadian pension funds, insurance companies, and other institutional investors, not the government. These entities make their own investment decisions based on risk and return, not geopolitics.

“The narrative about holding US debt is false,” McMahon said. “Even for China and Japan, which hold a lot, if they started selling and the market saw massive sales coming, bond prices would fall and everyone would hurt themselves.” In other words, a coordinated or unilateral sell-off would inflict losses on the seller as well, so it is unlikely to happen in a disorderly fashion.

It is entirely possible that these investors bought bonds when prices were higher, Paquet noted. “If you bought in 2017, for example, and sell today, you will realize a loss.” For McMahon, the more relevant question is whether global investors will remain willing to buy new American debt at reasonable yields. Maybe the answer is no. “Americans are still putting a lot of debt on the markets, and there is less interest in buying it, which pushes interest rates higher. That is where it really matters.”

Are Scott Bessent’s Efforts Bearing Fruit?

Last week, in an effort to curb the rise in bond yields and the government’s long-term borrowing costs, US Treasury Secretary Scott Bessent announced an increase in the size of buybacks of Treasury securities with maturities ranging from 10 to 30 years. The impact has been limited so far, but observers say the effects need to be monitored over several weeks or even months.

“When a Treasury secretary speaks this way,” said McMahon, “it’s like the market is beginning to smell blood.” The buyback program is a signal that the Treasury is aware of the rising yields, but it is not a silver bullet. “The amounts announced are very small relative to the total amount of debt,” Paquet said. “On the other hand, it sends a message that the US Treasury is aware that rates are rising. Could the United States take other measures to counter the rise in rates? Perhaps. But history shows that trying to control the bond market generally ends in failure. The only real solution is to clean up public finances.”

The Global Context

Mark Carney’s remarks are part of a broader global conversation about the limits of government debt. In recent years, many advanced economies have expanded their debt-to-GDP ratios to levels that would have seemed unimaginable a generation ago. The COVID-19 pandemic forced governments to spend trillions to support households and businesses, but the spending did not stop when the health crisis faded. Now, structural pressures such as aging populations, healthcare costs, and climate change are pushing public spending ever higher.

The United States is not alone in this predicament, but it is the most important case because of its size and the dollar’s central role in international finance. As Carney suggested, there may come a moment when markets lose patience, and then the cost of inaction becomes painfully clear. The cure, though unpleasant, remains the same: governments must put their fiscal houses in order, preferably before investors force them to do so at the worst possible time.

Source:La Presse News