When 5% Isn't Really 5%

When 5% Isn't Really 5%

Strategic spending, inflation and fiscal constraints are colliding and the bond market is beginning to show us what that collision costs.

I keep going back to the 5% on the 10 year bond because this is roughly what investors are demanding to lend money to the United States government for ten years. I keep thinking to myself where are the vigilantes because with our current US deficits I would be asking for much more but at first glance, 5% does sounds attractive. It certainly sounds better than the near-zero yields investors became accustomed to after the financial crisis and comparison or the benchmark sometimes dictates how we see things are first glance.

I think people are missing something very important, 5% is a nominal yield but what ultimately matters to an investor is how much purchasing power remains after inflation and that is where the current environment becomes much more interesting.

Five percent is not a 5% increase in purchasing power

September U.S. CPI was 3.7% higher than a year earlier. Producer prices were rising even faster, with the PPI for final demand up 6.3% year over year. You can also see the purchasing power when you go to the gas pump or when you try to buy groceries at the store. Let’s say, an investor earns 5% while consumer prices rise 3.7%, the simple inflation-adjusted return is only about 1.3% before taxes. Now if you think you are getting a good return by getting 1.3% before taxes with the current US deficit you might want to reconsider that number. 1.3% is a very different number than 5% and for an investor holding Treasuries in a taxable account, even that cushion can narrow considerably because Treasury interest is subject to federal income tax.

Just to state it again - a 5% quoted yield therefore does not mean an investor becomes 5% wealthier in real terms. Essentially, it means the investor receives five more nominal dollars for every hundred invested and what those dollars can purchase is another question.

I think that is the key especially given the environment we are entering. The bond market itself is giving us another useful signal. The latest 10-year Treasury Inflation-Protected Security yield has been around 2.8% in real terms. With a nominal 10-year yield near 5%, that puts the rough inflation breakeven around 2.2%. In other words, the market is effectively pricing a future in which inflation comes down substantially from today's 3.7% rate. There are technical qualifications around break evens, liquidity and risk premiums, but the implication is still important.

The Treasury market is making a fairly large bet that inflation eventually behaves. So I am asking myself, what happens if it doesn't?

The Federal Reserve is fighting demand while government creates strategic demand

The United States is trying to restrain inflation at exactly the moment it needs to build more physical capacity. This has been a focus of Core Sample - https://podcasts.apple.com/us/podcast/welcome-to-core-sample/id1896320695?i=1000766365120 and Signals - https://news.sturnellahq.com/

The build is focused on defense, power generation, critical minerals, rare-earth processing, advanced manufacturing, cybersecurity and infrastructure. These investments require steel, copper, specialty alloys, energy, equipment, skilled labor and enormous amounts of capital. The Department of War needs more industrial capacity while the Federal Reserve is trying to reduce demand across the broader economy.

That creates an unusual policy collision, the Fed can raise interest rates, that can have an impact and slow housing, it can make automobile financing more expensive, credit-card debt more painful, discourage businesses from borrowing but what it cannot do is manufacture another missile interceptor. I focus on this idea around timing that the government can want something quickly but that doesn’t create rare-earth separation capacity, produce more antimony or build another power plant and it cannot make a qualified defense supplier appear next quarter.

Those are supply problems and they take time and they are not on the same timeline as the US government wants them to be. They both operate with different timelines. Higher interest rates may suppress enough demand elsewhere to offset some of the inflation but the strategic demand itself is increasingly difficult to postpone.

The federal government faces the same interest-rate mathematics

This becomes more complicated when we look at Washington itself. The United States finished fiscal 2026 with a deficit of approximately $1.99 trillion, with roughly $7.4 trillion of spending against $5.4 trillion of revenue and higher yields do not only affect consumers and corporations. They eventually affect the government refinancing its debt.

Reuters reported today that the most recent 20-year Treasury auction produced a yield of 5.469%, the highest since 1986. Federal debt has passed $40 trillion and annual interest expense has reached roughly $1.36 trillion. That is where monetary policy and fiscal policy begin pushing against one another.

The Fed may need high rates to control inflation but they probably don’t want to pay those higher interest charges either because the Treasury has to finance enormous deficits at those higher rates. Noted in Core Sample and the procurement tracking, the Department of War needs additional spending. We have also focused on the energy system because those need additional investment. The country wants domestic critical-mineral supply chains and the US isn’t alone in this many countries outside of China are fighting the same battle. Canada also moved this week to make itself more competitive for mining investment, with Ottawa and Ontario announcing a coordinated federal-provincial permitting process intended to reduce duplication and accelerate priority projects in the mineral-rich Ring of Fire, alongside new infrastructure and financing support another sign that governments are beginning to recognize that strategic resources do not get developed if permitting and capital make projects uneconomic. In addition we are seeing private industry expectations around helping finance much of the capacity.

Capital now has a very high price, unfortunately, the timing isn’t great.

France shows what happens when the bond market starts charging for fiscal uncertainty

There is an even clearer example across the Atlantic. Germany's 10-year government bond is yielding roughly 3.33%. France's is around 5.08%. That is approximately 1.74 percentage points more. That comparison is useful because France and Germany use the same currency and operate under the same European Central Bank monetary policy.

The difference is therefore not simply the euro. The bond market is demanding a much larger risk premium to finance France. Reuters reported today that the French-German 10-year spread had reached approximately 174 basis points, its widest since the 2011 euro-area sovereign debt crisis. France's own 10-year yield briefly moved above 5.1%.

Investors are reacting to political instability, difficulty passing a budget and concern over public finances. France is attempting to reduce a budget deficit of roughly 5.4% of GDP, but proposed spending reductions are encountering substantial political resistance.

This is what fiscal constraint looks like in the bond market. It does not necessarily arrive as a dramatic default crisis. It can begin with investors simply saying: If you want my capital, you have to pay me more. (Hello Vigilantes)

Again, the higher yield creates another problem, more revenue goes toward interest and that leaves less room for services, investment and political priorities. Cutting spending becomes more difficult, taxes become more contentious and the bond market demands an even larger premium.

This is why nominal yields matter to gold

Normally, a 5% Treasury yield should be formidable competition for gold. Gold pays no coupon because it does not distribute interest and real Treasury yields near 2.8% represent a meaningful opportunity cost for owning a non-yielding asset.

Yet gold remains above roughly $4,000 an ounce and that deserves attention. It tells us investors may be looking beyond the quoted Treasury yield and looking fiscal deficits, debt-service costs, geopolitical risk, energy prices, strategic spending and the possibility that inflation remains structurally more difficult to suppress than the bond market currently assumes. If inflation returns toward 2%, a 5% Treasury can provide an excellent real return. If inflation remains closer to 4%, that real return becomes much smaller. If an investor pays tax on the nominal interest, the purchasing-power return can narrow further and if strategic spending, energy disruption and fiscal expansion keep placing upward pressure on physical costs, the inflation path becomes increasingly important. That is where gold begins competing with bonds differently.

Silver adds another dimension

Silver sits in an unusual position because it has monetary characteristics, but it is also an industrial material. That means it can participate in concerns about purchasing-power preservation while also being consumed by the physical economy. Such as defense, electronics, power infrastructure, solar, and advanced manufacturing.

That does not guarantee higher silver prices because industrial demand can weaken in a recession but it does mean silver sits directly at the intersection of monetary uncertainty and physical scarcity and that is increasingly interesting to me.

Not every hard asset is equal

Housing is often grouped with gold, commodities and other inflation hedges but I think that comparison has become less straightforward.

A house is absolutely a real asset and for someone who already owns a home with a low fixed-rate mortgage, that can be an extremely attractive position in an inflationary environment.

However, that changes for someone buying today, the economics are very different. The asset requires financing, insurance, property taxes, maintenance, repairs, utilities and eventually replacement of roofs, HVAC systems and other major components.

Those costs are themselves exposed to inflation, so the quote you get today for a repair may be very different in 6 months time. A home can rise in nominal value while simultaneously becoming substantially more expensive to carry.

Gold does not need repairs and silver does not receive an insurance renewal notice.

What I am getting at is that, it makes housing a capital-intensive hard asset, while monetary metals provide a cleaner exposure to scarcity and purchasing-power concerns.

The tipping point

I do not think we are necessarily approaching a dollar crisis but currency crisis are scary to live there. The U.S. dollar can remain strong relative to other currencies. Treasuries can remain the world's dominant reserve asset and U.S. markets can continue attracting enormous amounts of global capital. But a strong dollar internationally can still lose purchasing power domestically. The real tipping point would come if investors begin to conclude that inflation cannot return sustainably toward 2% without creating unacceptable pressure on households, businesses or the federal government's finances. That is where gold, silver and genuinely scarce productive assets begin to compete much more seriously with government debt and France offers an important warning about the other side of the equation. France also has a long history with monetary experimentation some readers will remember John Law and the Mississippi Bubble and although the mechanisms are very different today, confidence in money and government finance is never automatic.

Government borrowing costs are not insulated from political and fiscal credibility. The yield changes when investors become uncomfortable with debt, deficits and the government's ability to make difficult fiscal choices. As an example, Germany is paying roughly 3.3%, France is paying roughly 5.1%. That as a reminder is in the same currency, same central bank but a very different price for capital. The United States is currently paying roughly 5%.

That may represent an attractive nominal yield. It may also be telling us something about the amount of capital the government needs, the inflation investors must be compensated for, and the fiscal uncertainty they increasingly have to absorb.

That is why I think gold holding above $4,000 matters. The market may be starting to recognize that the most important return over the next decade will not necessarily be the highest quoted yield.

It will be the return that survives inflation.

Five percent is only 5% in nominal dollars.

Purchasing power is the return that ultimately matters.

Sturnella advises defense contractors, mining, energy, and critical infrastructure companies on CMMC readiness, SEC cybersecurity disclosure, and board-level cyber governance.

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Disclaimer: This article appeared on the Sturnella website at sturnellahq.com and is provided for informational purposes only. It does not constitute investment advice, financial advice, legal advice, or a solicitation to buy or sell any security or financial instrument. The information contained herein is based on publicly available sources and is believed to be accurate at the time of publication but is not guaranteed. Sturnella LLC is a capital markets cybersecurity and governance advisory firm and is not a registered investment adviser, broker-dealer, or financial institution. Always consult a qualified financial, legal, or investment professional before making any investment decision.

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