US residential construction activity contracted sharply in July, with total housing starts falling 12.4% from June to an annualized pace of 1.239 million. The decline missed the 1.35 million forecast by Reuters-poll economists, signaling persistent stress in the housing market driven by elevated borrowing costs.

Mortgage Rates and Fiscal Pressures

The slowdown reflects the direct transmission of bond market volatility to the housing sector. Mortgage lenders price long-term fixed loans against long-dated Treasuries, causing the 30-year mortgage rate to rise when Treasury yields climb. Borrowing costs currently sit between 6.67% and 6.77%, near their highest levels in over a year.

Lawrence Yun, chief economist at the National Association of Realtors, noted that these peak rates hit during the critical summer season, pulling back contract signings. With home prices near records, properties are remaining on the market longer.

Underlying fiscal pressures continue to support higher yields. The monthly deficit reached $432 billion in July, and national debt crossed $40 trillion. Treasury Secretary Scott Bessent announced a doubling of long-dated debt buybacks to $4 billion after the 30-year Treasury yield climbed above 5.3%. While this mechanically lowered yields, analysts stated it did not address root causes such as heavy government borrowing and persistent inflation risks.

Builder Caution and Permit Pullbacks

Builders are responding to the environment by preserving optionality rather than committing capital. Although overall permits rose 5% to 1.443 million and single-family permits increased 2.5% to 894,000, actual groundbreakings fell.

KPMG observed that builders are pulling permits because they represent optionality rather than commitment in a high-rate environment. Residential building material prices excluding energy rose 5% from a year earlier, the fastest annual pace since December 2022. Builder sentiment remains at 35, well below the neutral 50 line.

To manage inventory, 63% of builders used incentives, while 35% cut prices at an average discount of 6%.

What the Numbers Show

A divergence exists between permit activity and actual starts. Permits rose 5% to 1.443 million, indicating builders are securing land rights for future flexibility. However, starts fell 12.4% to 1.239 million, showing a reluctance to break ground due to current financing costs. This gap suggests builders are hoarding options rather than initiating projects, expecting rates to decline before committing capital.

Berkshire Hathaway’s Sector Bet

Despite the sector headwinds, Berkshire Hathaway is increasing its exposure to homebuilders. Greg Abel, who succeeded Warren Buffett, disclosed a new stake in D.R. Horton (NYSE: DHI) and increased holdings in Lennar (NYSE: LEN). This follows a $6.8 billion acquisition of Taylor Morrison.

Both D.R. Horton and Lennar have underperformed the State Street S&P Homebuilders ETF (NYSE: XHB), with Lennar down more than 34% over the last 12 months. Analysts suggest that large builders benefit from scale in accessing land and labor, whereas smaller players face higher bridge financing costs.

The United States bond market signaled deepening concerns over fiscal sustainability and foreign demand as the 30-year Treasury yield climbed to 5.31% on Monday, marking the highest level since June 2007. This surge occurred despite a weakening labor market, with July payrolls falling by 23,000, and easing expectations for a near-term Federal Reserve rate hike. Compounding these pressures, China drastically cut its US Treasury holdings to a nearly 18-year low in June, reflecting a strategic diversification of foreign exchange reserves amid rising geopolitical tensions.

Economist Steve Hanke warned that "bond vigilantes"—investors selling government debt to protest reckless fiscal or monetary policies—are driving the selloff. Hanke attributed the move to a "deadly cocktail" of monetary factors, including Divisia M4 money supply growth at 6.7% year-over-year, which exceeds his "Golden Growth Rate" of approximately 6%. He anticipates a further 50-basis-point rise in the 10-year yield, stating he is "very bearish" on bonds for a significant period. Hanke noted that the market has crossed informal thresholds watched by Treasury Secretary Scott Bessent, specifically the 4.5% level for the 10-year yield and 5% for the 30-year yield.

According to the U.S. Treasury Department, China’s holdings fell to $633.4 billion in June from $659.3 billion in May, marking their lowest level since September 2008. This reduction continues a trend that began during President Donald Trump’s first tenure, with China dropping to the third-largest foreign holder in March last year. Other major holders also reduced their positions: Japan’s holdings fell to $1.12 trillion from $1.14 trillion, while the United Kingdom’s dropped to $939.9 billion from $948.6 billion. Overall, foreign holdings of US Treasuries declined to $9.299 trillion in June from $9.371 trillion in May.

Rising Interest Costs Strain Federal Budget

The financial pressure on the US government is intensifying, with annual federal interest payments crossing $1.25 trillion according to Bureau of Economic Analysis data. This figure represents 3.15% of GDP, the highest proportion since 1991. The mechanism driving this increase involves the Treasury replacing maturing debt with new issuances at current higher rates, compounded by annual deficits approaching $2 trillion.

According to market commentator The Kobeissi Letter, the Treasury’s July budget deficit surged $141 billion year-over-year to $432 billion, the largest July total on record, pushing the trailing 12-month deficit to $2 trillion. Charlie Bilello, chief market strategist at Creative Planning, noted that federal spending has grown far faster than tax revenue over the past decade. He stated that US Federal Government Tax Revenue increased 65% to $5.3 trillion while Government Spending increased 96% to $7.3 trillion. This gap has more than doubled the national debt from $19 trillion to $39 trillion. Bilello added that the debt alone has grown by over $550 billion since July, with the country’s debt standing at $39.92 trillion at the time of writing. New data indicates US government debt has since reached $40.05 trillion as of Tuesday.

TLT ETF Tests Multi-Decade Lows

Investors tracking long-dated government bonds through the iShares 20+ Year Treasury Bond ETF (NASDAQ: TLT) are witnessing significant price declines, as bond prices fall when yields rise. The ETF dropped to $81.38 on Monday, hitting the lowest levels since June 2004. It fell 0.25% on Monday at $81.35 and gained 0.12% in extended trading. The ETF has lost 6.53% year-to-date and 5.57% over the past year. Benzinga edge rankings show the iShares 20+ Year Treasury Bond ETF has a Momentum score in the 18th percentile and a negative price trend across the short, medium, and long-term.

Other treasury-focused ETFs also faced headwinds. The Vanguard Extended Duration Treasury ETF (NYSE: EDV) has fallen 9.65% so far this year and 9.09% over the past year. It has $3.40 billion in assets under management and charges an expense ratio of 0.05%. The US Treasury 30 Year Bond ETF (NASDAQ: UTHY), which manages $181.37 million in assets with a 0.15% expense ratio, has fallen 6.50% year-to-date and 5.58% over the past year.

Ed Yardeni, a veteran investor, noted that the weak jobs report has not altered the scenario embedded in yields, suggesting markets still believe the labor market is at full employment while inflation remains above the Fed’s 2.0% target. He warned that "Bond Vigilantes" could drive yields further if the Fed loses credibility by keeping monetary policy too loose.

Political Backlash and Treasury Interventions

Recent actions by the Treasury Department suggest a strategic response to market pressures. Secretary Scott Bessent executed three moves in a single week: intervening to support the Japanese yen for the first time since 1998, altering quarterly debt guidance to potentially reduce long-bond sales, and publicly defending Fed Chair Kevin Warsh’s communication style. Nigel Green, chief executive of deVere Group, interpreted these actions as deliberate, noting that preventing Japan from selling US Treasuries to defend its currency is crucial to avoiding a seller’s market for American debt.

The U.S. Treasury decided on Wednesday to double its liquidity-support buybacks for long-dated bonds from $2 billion to at least $4 billion per operation. The move aims to improve liquidity amid strong investor demand to sell long-term bonds. Economist Mohamed El-Erian considered this a short-term fix that fails to address root causes, comparing it to past efforts like Operation Twist. El-Erian argued it amounts to financial engineering that buys time without addressing underlying fiscal problems. Meanwhile, Fed minutes showed several officials favored higher rates, with three voting for a hike, while many said a rate increase could be warranted if inflation remained elevated. Long-term Treasury yields nevertheless fell after the release, helped by the Treasury’s announcement of doubled buybacks.

The widening gap between the two-year yield at around 4.2% and the 30-year yield near 5.3% indicates investors are demanding a premium for holding long-duration debt, reflecting concerns about inflation, deficits, and Treasury supply rather than just short-term Fed policy. Last week, Sen. Rand Paul (R-Ky.) criticized the spending, saying, “we shouldn’t be spending $432B, that we don’t have, in a single month,” and called for cuts to government size, spending, fraud, and welfare benefits for undocumented immigrants. Veteran economist Peter Schiff said the national debt has surpassed $39.9 trillion and could hit $40 trillion by month-end, warning the Federal Reserve may respond by ramping up Treasury purchases, which he said could send consumer prices higher.

Despite selling off US debt, China has been steadily increasing its gold reserves, viewed as a safeguard against geopolitical and financial risks. The People’s Bank of China has raised its bullion holdings for the 21st consecutive month in July, totaling 76.08 million troy ounces.

What the Numbers Show

The divergence between short-term and long-term yields reveals a structural shift in market pricing. While the two-year yield remains sensitive to Fed policy expectations, the 30-year yield’s elevation to 5.31% demonstrates that investors are increasingly focused on the long-term fiscal trajectory of the US government. The fact that yields rose despite a drop in payrolls and a decline in September rate hike odds from 53% to 36% suggests that the market perceives the risk of persistent inflation and growing debt service costs as more material than immediate economic slowdowns or monetary tightening fears. Concurrently, the reduction in foreign holdings—particularly China’s drop to an 18-year low—indicates that traditional buyers are stepping back, potentially leaving the US Treasury reliant on domestic investors or the Federal Reserve to absorb the record supply of debt. Hanke’s warning of a further 50 bps rise in the 10-year yield underscores the belief that inflation expectations, driven by money supply growth above his target rate, remain entrenched.