The biggest news this week—and last, since there was no update then—is that the U.S. Treasury market now has its own inverted yield curve. As of December 1, it looks as follows:
Figure 1
Source of raw data: U.S. Treasury
As we noted earlier in the week, an inverted yield curve can safely be interpreted as the market expecting lower inflation in the near future. Therefore, this is good news for the U.S. economy, and for investors who do not like negative real interest rates.
This week, we also published another estimate of just how much the U.S. debt will cost U.S. taxpayers in the current fiscal year. Our forecast is based on two scenarios, with both being based on the same growth rate for the debt itself, of 0.37 percent per month.
Scenario 1 assumes that the debt cost—defined as the sum total of the median yields paid out per U.S. Treasury auctions—will increase linearly throughout the remainder of the fiscal year. The assumed growth rate is the same as seen in November, namely 7.13 percent per month.
Scenario 2 assumes that the yield cost increases at a decreasing rate, where next month's growth rate is 9/10ths of that in the previous month. This reduces the growth rate to 2.76 percent in September 2023.
The debt is plotted in Figure 2 as columns, while the solid and dashed black lines show the growth trajectories of the debt cost under Scenario 1 (solid) and Scenario 2 (dashed):
Figure 2
Source of raw data: U.S. Treasury
In both scenarios, the total debt cost will pass the $1 trillion threshold before the end of the fiscal year.
There are points to be made about these scenarios, the first of which is the assumption about the linear growth in the debt stock. It is uncontroversial insofar as current fiscal policy is concerned, with Congress having shown no interest in addressing the structural debt. However, if a razor-thin Republican margin in the House actually starts working on a plan to address the debt, there is a theoretical chance that Congress—while the plans are being hashed out—agrees to a general policy of ad-hoc spending restraint. This could moderate the growth of the debt, though not by so much that it would materially affect the growth of the debt cost.
A more contentious assumption is that which says the yield cost will continue to rise, either linearly or at a decreasing rate. If interest rates stabilize in the 4-4.5 range, as they seem to have done now, is there not a case to be made for the average yield on the U.S. debt to stabilize as well?
The answer is negative, for one simple reason: a massive body of debt is going to mature during this fiscal year, which was sold at auctions during the pandemic. More than $1.6 trillion of that debt currently costs the Treasury 0.21 percent per year, on average; if that were to be refinanced at an average four percent, the annualized cost for the debt would go up by well over $60 billion.
Please note that this is an annualized estimate; the actual fiscal effect depends on when the debt replacement is done, i.e., how much of the fiscal year remains at the point of auction. Nevertheless, this example illustrates the key point, namely that:
- even if the debt itself stopped rising, and
- even if interest rates at Treasury auctions stopped going up,
the cost of the debt would continue to increase simply by the forces of debt rollover.
If the debt cost exceeds $1 trillion for the current fiscal year, it will make the debt the second biggest item in the federal budget.
We expect that when this cost trend becomes apparent to sovereign-debt investors, they will see an emerging risk for a partial U.S. debt default, a.k.a., a fiscal "haircut". This will put significant upward pressure on interest rates at both the auctions and the secondary market. As this happens there will be renewed pressure on the Federal Reserve to re-enter the sovereign-debt market. If it resists, which is likely, the stakes will rapidly escalate.
As always, to keep track of the market's confidence in U.S. debt, keep an eye on the Tender-to-Accept ratios we report on here, on a daily basis. When the T/A falls, it means fewer investment dollars are available for every dollar of debt the Treasury wants to sell.
Another indicator is a negative correlation between the T/A ratio and median auction yields. Given a declining T/A, a more pronounced negative correlation means we are moving steadily toward a fiscal crisis.
We report on all the relevant numbers here, on a daily basis. Click to sign up for free daily updates.
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We do not give investment advice.
This blog provides analytical information solely for the purposes of 1) predicting the cost of the federal debt, and 2) for assessing the risk for a U.S. fiscal crisis. All information published here, forecasting and other, is based on publicly available data from the U.S. Treasury, including but not limited to approximately 65 percent of the current debt; on macroeconomic data, including but not limited to monetary policy decisions by the Federal Reserve; and on macroeconomic theory.
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