US Debt Interest Costs Soar as Iran Conflict Adds Billions to Budget

Jakarta, CNBC Indonesia - The US-Israel conflict against Iran is adding new pressures to the US economy. Not only through oil prices and inflation, but also through rising government borrowing costs.

Citing the Financial Times, US taxpayers could face additional burdens from the conflict. This is due to rising yields on US government bonds as investors fear prolonged hostilities will reignite inflation.

Pressure in the US bond market is intensifying. Government borrowing costs for several maturities have reached their highest levels since 2007, as the US-Israel conflict with Iran enters its 12th week—almost three months.

Investors are selling US government bonds, anticipating rising inflation. As bond prices fall due to selling pressure, yields rise. For the US government, higher yields mean increased borrowing costs.

The yield on 10-year US Treasury bonds is now at 4.58%, up from around 4% before the conflict began.

This level is higher than the baseline assumption of the US Congressional Budget Office (CBO), which in February projected a 10-year yield of 4.13% for this year.

This means the current 10-year yield is 0.45 percentage points above the CBO’s initial estimate. The 10-year government bond yield is also at its highest since January 2025, while the 30-year yield has reached its highest level since July 2007.

Interest Payments Could Surge by Billions of Dollars

The impact of rising yields is immediately felt in the US government’s budget.

If the 10-year yield remains at 4.58% for the remaining four months of the current fiscal year ending 30 September 2026, US debt interest payments could increase by approximately $8 billion, equivalent to Rp141.84 trillion at an exchange rate of Rp17,730 per dollar.

The burden could be much larger if pressures persist. If the 10-year yield stays at the same level throughout the 2027 fiscal year, additional debt interest payments could exceed $30 billion.

Meanwhile, US debt interest payments have already been on a sharp upward trajectory.

CBO projections indicate US government interest payments will more than double, from $1 trillion or 3.3% of GDP in 2026 to $2.1 trillion or 4.6% of GDP by 2036.

The main issue is the US budget deficit remains wide. If the government fails to curb it, borrowing needs will stay high. As interest rates rise, budgetary burdens automatically increase.

US Treasury Secretary Scott Bessent has criticised the CBO’s projections as overly pessimistic. He argues the US economy still has room for stronger growth under President Donald Trump’s policies, which could ease the tax burden from interest payments if economic growth is higher.

However, market participants remain uneasy. Major investors fear that rising long-term yields could create a vicious cycle.

As debt costs rise, the government must spend more on interest payments. To cover this, it may need to borrow even more.

Bill Campbell, portfolio manager at DoubleLine, said the US remains on a steep debt trajectory. He noted that markets are seeing insufficient political will to address the deficit.

Rising Inflation, Market Demands Higher Rates

The pressure on yields is also spreading to the American public. Rising long-term interest rates are pushing up mortgage rates, making home purchases increasingly expensive in the US.

Pressure signals are clear as the US 30-year government bond auction recorded a 5% yield for the first time since 2007. This indicates investors demand higher returns for holding long-term government debt.

Market sentiment has grown more sensitive after the US reported producer inflation of 6% in April—the highest in four years.

Producer inflation is significant as it reflects rising costs at the corporate level. If production costs increase, consumers typically face higher prices in the following months.

Following the data release, investors’ one-year inflation expectations rose above 4%. These concerns have triggered ongoing bond selling.

Markets are also questioning the readiness of the US Federal Reserve to address new inflation pressures.

At its last meeting, the Fed maintained a dovish policy stance despite oil prices rising nearly 50%. Three Fed presidents dissented from this language.

Citing the Financial Times, Bob Michele, Chief Investment Officer and Head of Global Fixed Income, Currency and Commodities at JPMorgan Asset Management, said global yield increases reflect investor doubts about central bank policies.

He said markets view central banks as overly cautious, fearing the economic risks of raising interest rates.

In this environment, bond investors are playing a significant role. In market parlance, they are known as ‘bond vigilantes’—investors who pressure governments by selling bonds when fiscal policy or inflation is deemed out of control.

If central banks fail to respond to inflation pressures, the bond market could force borrowing costs higher. This means governments will continue to pay more, whether due to inflation, deficits, or declining market confidence.

The US government and the Fed have some options to ease long-term yield pressures. One is issuing more ultra-short-term debt. However, this is only a temporary fix as it does not address the core issues of high debt and deficits.