“The Fed keeps jawboning that interest rates are going to rise a lot in coming years. Tune out the noise” –Paul Ebeling
The US economy no longer needs or wants highly accommodative policies Fed Chairman Powell told the Senate. The Fed is aiming to end its economy-supporting asset purchases in March.
The Fed says it intends to raise benchmark interest rates soon…
- Fed officials have talked about a raise by as much as 100 basis points (that is, one percentage point) – which would lift interest rates to the 1% to 1.25% range.
- The CME FedWatch Tool forecasts a 25% chance that rates will be between 1.25% and 1.50% by December.
- And consensus forecasts suggest interest rates will be upwards of 2% by late Y 2023.
There is good reason for the Fed to be concerned about inflation, which in December clocked in at an annual rate of 7% the highest in 40yrs. Raising interest rates is 1 of the tools in the Fed’s boxx to strengthen the buying power of USD, which offsets inflation.
Higher interest rates mean that it would cost more to borrow and, crucially, for would-be buyers of real estate. Higher rates can also drag down share prices.
But the biggest problem with higher interest rates is not that. Higher rates can doom the federal budget.
In Y 2020, the US government’s federal budget amounted to $6.6-T, according to the nonpartisan Congressional Budget Office. Of that, $4.6-T was for “mandatory spending” including entitlement programs like Social Security, Medicare, and Medicaid.
Another $1.6-T was in “discretionary” spending, which encompasses defense and about everything from health to justice to agriculture to education.
The remainder is $345-B in interest payments on federal debt, which currently stands at more than $29-T. At 5.3% of total spending.
That sum, according to the nonpartisan think-tank Committee for a Responsible Federal Budget, is more than 4X what the government will spend on housing, more than 4X what Uncle Sam spends on K-12 education and 8X what it will spend on science, space, and technology.
As rates rise, those interest expenses rise as well. And the thing is that $345-B that the government pays in debt service is at historically low interest rates. But with the Fed raising interest rates, that is going to change too.
A 1 pt rise in interest rates would boost the amount of money paid on interest on the federal government debt to $530-B.
A 2 pt increase would raise it to $750-B. That’s about as much as all government spending on defense, and it is unsustainable.
And 3 pts higher, and the government would be spending nearly $1-T on interest expense alone, which is around 20% of total federal tax revenue and is approximately as much as what is spent on Social Security benefits every yr.
At this point, no one is talking about interest rates at the 3% level. Remember as recently as Y 2008, interest rates were at 4%.
If you are doing the math, the numbers do not add up.
The federal government is staring down the barrel of a real debt crisis. It could imperil the stability of the USD and throw into further doubt the status of the Buck as the world’s reserve currency.
That begs the the Big Q: Will interest rates really rise?
The Big A: The Fed says it wants to, the markets are ready, but the data will change.
Have a healthy, prosperous weekend, Keep the Faith!