Before I share with you highlights by Daniel Bergstresser from his research piece on government debt (Brandeis University, December 5, 2022), keep the following thought top of mind:

  • The most recent data on this, as of Q3 2022, show that the effective interest rate on all of the Treasury’s debt is 2.40%
  • The Fed Funds rate is now 4.50%.
  • The weighted average maturity of U.S. government debt is approximately five years. As bonds mature, they get refinanced at a higher rate.
  • The longer rates stay high, the higher the interest costs the U.S. government must make on the debt it owes.
  • To understand how rising interest rates stress the system, if the average U.S. government debt rate rises from 2.40% to 10.40%, the interest expense alone will take up close to 100% of the tax dollars the government currently collects. 10.40% on $31 trillion in debt is $3.22 trillion annually.
  • In 2021, the total revenues of the U.S. government totaled around 4.03 trillion USD. Revenues include individual and corporate income taxes, payroll taxes, and other taxes.
  • It’s estimated that the U.S. government spent $7 trillion in 2021 and $6 trillion in 2022. That shortfall is financed by more debt.
  • You can see the problem. As we used to chant as kids during our baseball games, “We are slowly putting pressure on the pitcher and the catcher.”
  • In this case, the pitcher is our U.S. government, and the catcher is the Fed.

Bottom line: The Fed cannot afford to lose the battle to inflation. This is why I keep saying inflation is the kryptonite to Fed policy.

 

Hat tip to Tom McClellan, Editor, The McClellan Market Report

 

McClellan shares one more chart. His point is we really can’t tax people any more than we are currently.

Source: Econfact.org

 

Let’s first jump to the conclusion:

Rising levels of debt service contribute to fiscal challenges that our country faces. The cost of debt service will depend on both the level of debt outstanding and the level of interest rates. Debt has risen to levels that are high by historical standards, but — until last year — that increase has coincided with very low interest rates that have kept the costs of debt service relatively low. However, the high levels of debt mean that increases in interest rates like those that we have seen in the past year will either have a large impact on our country’s budget deficits or will require increases in taxes or reductions in spending.

Most of the current government debt will mature within the next three years. New borrowing, and debt that must be rolled over, will pay current market interest rates.

The Facts:

  • The government’s bill for its interest payments on debt reflects the size of the debt and the interest rates on the debt.
  • Borrowing costs have been rising across the U.S. economy as the Federal Reserve has been raising interest rates in an effort to curb inflation.
    • The Fed funds rate has gone from 0% to 4.5%, and the 10-year Treasury yield has gone from under 1% to currently 3.55%. Interest rates on treasuries of different maturities had also risen: The 2-year went from 0.55 to 4.33%, and the 30-year bill went from 1.76% to 3.74% in the year ending on November 30.
  • The Treasury does not decide how much to borrow, but how to borrow.
    • The U.S. Treasury considers the tradeoffs involved in selling debt of different maturities and whether to choose fixed or adjustable-rate bonds when deciding how to finance the current budget deficit and the rolling over of maturing debt.
  • The interest payments on debt have varied over time with the level of debt and the interest rate.
    • Net interest payments rose from about 7 percent of total fiscal outlays in the mid-1970s to over 15 percent of fiscal outlays in the mid-1990s (see chart).
    • This was at a time when the overall debt held by the public as a percentage of GDP grew from 23 percent to 48 percent.
    • The reduction of debt payments from the mid-1990s to the mid-2010s reflects both lower interest rates and a lower level of debt.
    • Although the debt-to-GDP ratio rose between 2009 and 2017, net interest payments as a share of total federal outlays remained below 7 percent during this period, primarily because of low-interest rates.
    • Net interest payments on the debt as a percentage of total fiscal outlays have now started to rise with the increase in interest rates. (SB Here: Currently over 12% of total federal outlays.)
  • Looking forward, the interest payments on debt will depend upon, among other factors, how much debt will come due in the next few years.
    • The U.S. Treasury issues debt with maturities as short as one month and as long as 30 years.
    • Thirty percent of this outstanding debt, amounting to $6.7 trillion, will mature and need to be refinanced during fiscal 2023.
    • An additional $300 billion in floating-rate debt, while not maturing during fiscal 2023, pays interest rates that will reset with market rates during that year.
    • An additional $2.5 trillion in debt maturing during 2023 will make coupon and principal payments that will be adjusted based on the inflation rate prevailing at that time.
  • The maturity structure of debt matters for debt payments because interest rates on new and rolled-over debt may be different from interest rates in the past.
    • As an example, almost $7 trillion worth of debt held by the public will need to be refinanced during the 2023 fiscal year.
    • Each percentage point increase in interest rates on that refinanced debt will mean $70 billion per year more in net interest payments in that first year, or about 10 percent of the United States defense budget requested for 2023.
    • The most current forecast is that interest payments will reach and even exceed the percentages of the 1980s and at the turn of the century. This is partly due to an increase in the forecasts of Treasury bond yields of about 1.2 percentage points for 10-year yields and two percentage points for 3-month yields.
    • But market interest rates since the CBO’s mid-2022 forecast have come in much higher than they forecast then; they are now more than 1 full percentage point higher than forecast for bonds with 10 years to maturity and 2 full percentage points higher than forecast for 3-month Treasury bills.
  • Although sometimes it is claimed that inflation reduces the burden of debt as a share of that GDP, that may not be the case now.
    • Increases in inflation raise nominal GDP, that is, GDP at current prices. For that reason, it is sometimes claimed that inflation may reduce the burden of debt as a share of GDP. But interest rates on new debt, on floating rate debt, on inflation-adjusted debt, and debt being rolled over will also rise with inflation.
    • Lenders will demand higher interest rates to compensate them for being paid back in dollars that are worth less in the future. The short maturity structure of outstanding debt means that much of the debt will be refinanced, and the interest rates will reflect current and expected inflation. Thus, research suggeststhat inflation itself is unlikely to contribute much to a reduction in the debt-to-GDP ratio.

Here is an up-to-date look at the problem:

 

 

It’s estimated that the federal government spent $6.27 trillion in FY 2022. This means federal spending was equal to 25% of the total gross domestic product (GDP), or economic activity, of the United States that year. $766 billion in interest expense equals 12.21% of the budget. Bottom line: It’s likely going higher.

 

US Economy

 

  • The PMI report from S&P Global increasingly looks recessionary.

 

 

  • Manufacturing activity shifted deeper into contraction territory this month as demand plummets (2nd panel).

 

 

  • On the other hand, the World Economics SMI report still shows modest growth.
  • The NY Fed’s Business Leaders Survey indicates that the region’s service firms are struggling.

 

 

  • How does the current Fed tightening cycle compare to previous ones?

 

 

  • The yield curve remains heavily inverted.

 

 

  • The yield curve steepening will signal the onset of a recession.

 

 

  • Housing starts held up well last month, but building permits declined more than expected.

 

 

  • Housing starts are now down 35% from November of 2021.

 

 

  • The weakness was in single-family housing, with permits dipping below 2016 levels, down over 30% vs. November of 2021.

 

 

  • Since fewer people can afford a home, the number of apartment units under construction hit a record high.

 

 

  • The year-over-year decline in homebuilder sentiment has not been this severe in decades.

 

 

  • Housing affordability hit a new low recently

 

 

  • The consensus GDP growth forecast for 2023 (full year) hit 0.3%, while forecasts for the core PCE inflation were upgraded again (stagflation).
  • In the past, recession predictions underestimated the severity of the downturn.

 

 

  • Strong employment continues to support consumer confidence.
  • Inflation expectations eased on softer gasoline prices.
  • The gap between the Conference Board’s and the U. Michigan’s confidence indicators remains wide.

 

 

  • Unemployment applications are holding below pre-COVID levels (at multi-year lows), suggesting that recent layoffs are not having a meaningful impact on the labor market.
  • The Q3 GDP growth was revised higher again. Consumer spending and business investment were stronger than initially reported.
  • The Conference Board’s index of leading economic indicators saw the biggest monthly drop since the COVID shock.

 

 

  • The 6-month decline in the leading index has never been this large without a recession.

 

 

  • The Kansas City Fed’s manufacturing report showed rapid deterioration in the region’s factory activity.

 

 

  • Demand is tumbling.

 

 

  • Hiring has stalled.

 

Market Data

 

  • Who owns the US stock market?

 

 

  • No Santa rally this year.

 

 

  • The market tends to have a near term peak when the proportion of S&P 500 members that are above their 50-day moving average exceeds 90%.

 

 

Quote of the Week

 

“Always remember that you are unique – just like everybody else.” – Unknown

 

Picture of the Week

 

 

 

All content is the opinion of Brian J. Decker