Higher rates fuel growing chorus of deficit concerns | ET REALITY


The U.S. government’s persistent budget deficit and mounting debts were low on Wall Street’s list of worries when interest rates were at lows for years. But borrowing costs have risen so sharply that it is causing many investors and economists to worry that America’s large debt may become less sustainable.

Federal Reserve officials have raised interest rates to around 5.1 percent since the beginning of 2022 in a bid to control inflation. Officials predicted at their meeting last month that interest rates could remain high for years to come, shaking expectations among investors who had bet that rates would fall noticeably next year.

The realization that the Federal Reserve could keep borrowing costs high for a long time has combined with a cocktail of other factors to soar long-term interest rates in financial markets. The 10-year Treasury rate has been rising since July and hit new 23-year highs this week. That’s important because the 10-year Treasury bond is like the backbone of the market: It helps drive many other borrowing costs, from mortgages to corporate debt.

It is difficult to pinpoint the exact cause of the latest increase in Treasury rates. Many economists say a combination of factors are likely helping to fuel the pop, including strong growth, fewer foreign buyers of U.S. debt and concerns about the sustainability of the debt itself.

What is clear is that if rates remain high, the federal government will need to pay more interest to investors to finance their loans. The US gross national debt amounts to just over $33 trillion, more than the total annual output of the US economy. Debt is expected to continue growing both in dollar terms and as a proportion of the economy.

While the rising cost of carrying so much debt is fueling conversations among economists and investors about the appropriate size of the government’s annual borrowing, there is no consensus in Washington on reducing the deficit in the form of higher taxes or big spending cuts.

Still, the renewed concern is a sea change after years in which mainstream economists increasingly thought the United States may have been too timid when it came to its debt: Years of low interest rates had convinced many of that the government could borrow cheap money to pay. for relief in times of economic problems and investments in the future.

The deficit as a percentage of the economy increased this year under President Biden even though the economy was growing.Credit…Pete Marovich for The New York Times

“The magnitude of the problem depends, and it depends very critically on interest rates,” said Jason Furman, a Harvard economist and former economic official during the Obama administration. “That’s changed a lot,” so “your view of him on the deficit should change too.”

Mr. Furman had previously estimated that the rising interest cost on the federal debt would remain sustainable for some time, after accounting for inflation and economic growth. But now that rates have risen so much, the calculus has changed, he said.

Since 2000, the United States has had an annual budget deficit, meaning it spends more than it receives in taxes and other revenue. It has covered the gap by borrowing money.

Tax cuts, spending increases and emergency economic assistance approved by Democratic and Republican presidents have helped fuel growing deficits in recent years. So has the aging of the American population, which has raised the costs of Social Security and Medicare without corresponding increases in federal tax rates. The deficit as a percentage of the economy increased this year under President Biden even though the economy was growing, just as it did in the pre-pandemic years under President Donald J. Trump.

Now, borrowing costs are about to widen the gap.

Higher interest rates are the primary cause of what the Congressional Budget Office projects will be a doubling of the federal budget deficit over the past year. The deficit, when properly measured, grew from $1 trillion in fiscal 2022 to an estimated $2 trillion in fiscal 2023, which ended last month.

If borrowing costs rise further – or simply stay where they are for an extended period – the government will accumulate debt at a much faster pace than officials expected even a few months ago. TO Budget update released by Biden administration economists. In July they predicted that average annual interest rates on 10-year Treasury bonds would not exceed 3.7 percent at any time over the next decade. Those rates are now around 4.7 percent.

That recent rise in longer-term bond yields is related to a number of factors.

While the Federal Reserve has been raising short-term interest rates for about 18 months, longer-term bond rates have remained fairly stable through the first half of this year. But investors have been slowly coming to terms with the possibility that the Federal Reserve will leave interest rates high for longer, in part because growth has remained strong even in the face of high borrowing costs.

At the same time, there have been fewer buyers of government bonds. The Federal Reserve has been reducing its bond balance sheet as it reverses a pandemic-era stimulus policy, meaning it no longer buys Treasuries, taking away a source of demand. And key foreign governments have also stopped buying bonds.

“We have narrowed down to a smaller universe of buyers,” said Krishna Guha, head of global policy and central bank strategy at Evercore ISI.

Some analysts have suggested that the rally in bond yields could also be related to concerns about debt sustainability. To pay higher interest costs, the government may need to issue even more debt, compounding the problem and focusing attention on America’s gigantic debt pile, said Ajay Rajadhyaksha, global president of research at Barclays.

“The problem is not just that number,” he said, referring to the growing deficit. “The problem is that this economy is as good as it gets.”

Several economists have said that’s the crux of the issue: The United States is taking on a lot of debt even at a time when the unemployment rate is very low and growth is strong, so the economy doesn’t need much government help.

“Right now we have an incredible amount of issuance at the same time that the Federal Reserve is sending higher messages for longer,” said Robert Tipp, chief investment strategist at PGIM Fija Income, noting that typically the largest issuances occur in periods of turbulence when central bank policy is more accommodative. “This is like a wartime budget deficit, but without any help from the central bank. That’s why this is so different.”

The Treasury Department has sold about $16 trillion in debt during the year through September, about 25 percent more than the same period last year, according to data from the Securities Industry and Financial Markets Association. Much of that issuance replaced existing maturing debt, leaving net debt issuance of about $1.7 trillion, more than at any time in the last decade except for the crisis-induced bond binge. pandemic in 2020. The Treasury’s own advisory committee forecasts the size of government debt sales is expected to increase by another 23 percent in 2024.

Maya MacGuineas, chairwoman of the bipartisan Committee for a Responsible Federal Budget and a longtime advocate for reducing deficits, said it was difficult to say what had caused rates to rise recently. Still, she said, the measure serves as a “reminder.”

“From a tax perspective, the story is very simple: If you borrow too much, you become increasingly vulnerable to higher interest rates,” he said.

Santul Nerkar contributed with reports.

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