Divided Government Could Lower Borrowing Costs or Raise Them
Less spending could mean less government borrowing, but a fight over funding the government could rattle investors and lift mortgage rates.
Marketplace · A divided government could shift the bond marketGridlock in Washington could push the interest rate you pay in either direction, and the lever is the market for Treasury bonds, the government's IOUs to investors.
A bond's yield is the interest Washington must pay to borrow. Yields have risen in recent months partly because federal debt has passed $40 trillion, so the government must sell more bonds while investor appetite has cooled.
Peter Conte-Brown, a Wharton professor, says demand has become more satiated, so investors are charging a bigger premium, especially for bonds that do not come due for many years.
The incoming divided government, produced by the midterm vote, could ease that pressure once the new Congress is seated. With the White House and Congress held by rival parties, big new spending plans would face a tougher path to approval, and so would big tax reductions.
Cooper Howard, who leads bond strategy at Charles Schwab, says that points to more fiscal constraint. Less spending and lower deficits would mean less new debt, fewer new bonds for sale, and yields could tick down.
That matters beyond Washington, says Campbell Harvey of Duke University. When Treasury yields rise, yields on corporate bonds, consumer loans, and, importantly, mortgages usually rise too. When Treasury yields fall, those other rates tend to ease.
Harvey adds another calming possibility. With Democrats holding more power in Congress, they would have a bigger say in President Trump's picks for the Federal Reserve, the central bank. He says the chance of one party capturing the Fed has decreased.
A Fed free from party control is less apt to take steps that stir inflation, which can also push bond yields higher. But division brings a sharper risk in the other direction.
Congress and the president must still agree to fund the government. If they do not, parts of the government can shut down.
Peter Conte-Brown of Wharton says, "A long, drawn-out shutdown could push us over the biggest of cliffs, which is default." Default means Washington fails to pay its debts on time.
That outcome is unlikely, but even the possibility could send bond yields up. So the same stalemate that could restrain borrowing could also raise it.
Questions people ask
What exactly is a Treasury bond yield?
A Treasury bond is an IOU from the federal government. Investors lend Washington money now, Washington pays interest, called the yield, and repays the principal later. Yields are closely watched because they set a baseline for many other U.S. interest rates.
What is the difference between a shutdown and a default?
A shutdown happens when Congress and the president fail to approve funding, forcing many agencies to close temporarily. A default is more serious: the government fails to pay money it already owes, including interest to bondholders. Investors view default as a breach of trust, so they usually demand much higher yields to keep lending.
Why do mortgage rates follow Treasury yields?
Lenders and investors treat Treasuries as the safest U.S. loan, so other loans are priced above them to reflect extra risk. A 30-year mortgage, for example, is often compared with a long-term Treasury bond because both last many years. When Treasury yields move, mortgage and corporate borrowing costs usually follow.