Alert: About the recent increase in interest rates…

Like most investors, I’ve started paying closer attention to interest rates.

The initial motivation: came this summer via my trusty mortgage ARM — which hovered around 3% for a decade or so — jumped to 4% last year and is being reset to 5% this year.

Ouch.

Now, with the Fed “normalizing” interest rates, i.e. jacking rates up, I’m on full alert.


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All of this got me wondering about the impact of rising rates on the Federal budget…

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Before answering that question, draw some perspective from the chart above.

Since 1990, the Fed Funds Rate has arguably trended downward with some wide ups & downs.

I say “arguably” because the statistical variability is so high.

Outboarding the past decade of near-zero rates, the “normal” looks like 2.5% to 5%.

Currently, the Effective Fed Funds Rate is approaching the lower level of “normal”.

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OK, so back to the question: What’s the impact on the Federal Budget?

The obvious answer: a HUGE hit.

The Feds are already obligated to about $450 billion annually in interest to ‘service the debt’’.

That’s about 10% of the total Federal budget.

Everybody knows that budget deficits are high and growing … so the national debt has grown to over $20 trillion.

With interest rates near zero, the required interest payments were contained.

But, as interest rates move up … and spending continues unabated … it’s simple arithmetic that interest on the debt will skyrocket as the government’s increasing debt matures and needs to be refinanced (at higher interest rates).


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Analytical note from Prof. Gary Blemaster — my finance go-to-guy

Under Obama the government ran the average debt maturity down to about three years. 

We missed a fabulous opportunity to sell 30 and 40 year bonds at very low rates. 

Post-Obama, the average maturity has inched back up to the 5-year range, but we are still extremely vulnerable to the interest rate rise driven by the Fed increases. 

The debt rolls over relatively quickly and we have to borrow and reborrow (at higher rates).

Considering the current debt level and average maturity, debt service (i.e. interest paid on the debt) is on track to surpass a half trillion dollars this year or nest year.

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The implication: a big budget squeeze on other spending … think social programs and defense … or higher taxes (ouch) … or, induced inflation to devalue the debt.

Why isn’t there more chatter about the impact of these rising rates on the Federal budget?

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One Response to “Alert: About the recent increase in interest rates…”

  1. Jim Muzzall Says:

    You might enjoy Big Debt Crises by Ray Dalio. He is pretty concern about interest rates and the ability to recover once we get into correction terriroty. The book is more macro focused on fiscal and monetary policy of major recessions, but the principles still apply. Good holiday reading. https://www.principles.com/big-debt-crises/

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