Over the past two years, benchmark rates in the United States have skyrocketed from 0% to over 5%. This significant shift is not only a topic of interest for investors speculating on the Federal Reserve’s interest rate cuts but also a game-changer for U.S. Treasuries. They are now reclaiming their traditional role in the economy, offering investors a reliable and substantial source of income. Last year, investors reaped nearly $900 billion in annual interest on U.S. government debt, a figure that is expected to rise as almost all Treasuries now offer yields of 4% or higher.

Two recent economic trends have favoured government bonds. Firstly, while inflation is close to the point where the Fed might consider cutting rates, progress toward its 2% target has stalled, pushing rate-cut expectations at least towards the end of the year. Secondly, and perhaps more importantly, the economy continues to outperform expectations, suggesting that the Fed won’t need to cut rates as much when it does begin. Fed Chairman Jerome Powell emphasized this wait-and-see approach in his remarks following the latest FOMC meeting. No one worries as much about what could go wrong if the economy’s gears falter. The notion of a recession in the U.S. economy, prevalent among some analysts at the end of last year, has vanished from the radar.

In February, the Congressional Budget Office projected that interest and dividends paid to individuals would reach $327 billion this year, more than double the mid-2010s, and continue to rise each year over the next decade. In March alone, the Treasury Department paid about $89 billion in interest to debt holders, roughly $2 million per minute.

It’s a notable paradox that income from Treasuries is a key player in the Fed’s new narrative of ‘higher for longer’. Alongside the surge in stock prices, the interest paid on Treasuries and other bond investments generates significant wealth effects among Americans. This additional liquidity acts as stimulus checks, bolstering the remarkably resilient economy.

Of course, the appeal of holding U.S. government bonds is that they’re not supposed to incur losses, are less volatile than stocks, and offer a fixed-rate return above inflation. This reset, painful as it may be, has now paved the way for higher future yields and a normalized fixed-income market.

Money market funds, which invest in short-term securities, saw their assets swell to a record $6.1 trillion last month. Meanwhile, bond funds garnered $300 billion in 2023 and $191 billion this year, reversing the outflows seen in 2022, which were the largest in recent memory. According to Fed statistics, household and nonprofit organization debt has surged by 90% since the beginning of 2022 to reach a record $5.7 trillion.

There’s undoubtedly no certainty that this will persist. However, there are strong reasons to believe that yields won’t return to their post-financial crisis levels even after the Fed begins cutting rates. This means fixed-income securities will likely remain in high demand. Stubborn concerns about inflation, fueled partly by trends such as supply chain deglobalization, will likely prevent rates from falling too far as investors seek protection against inflation risk. After adjusting for inflation, yields have now risen above 2%. The last time this happened was before the 2008 financial crisis. Then there’s the massive U.S. deficit, which a constant supply of new bonds will almost certainly finance. Not only will this keep yields elevated, but it will also provide a growing source of interest income for bond investors.