Rising Interest Costs Make U.S. Debt a Long-Term Market Threat
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Rising Interest Costs Make U.S. Debt a Long-Term Market Threat

Story Highlights

Analysts weighing in on the risks to markets going forward worry less about deficits but see downside in the Treasury’s interest expenses spiking higher.

Market analysts, who had previously pointed to the huge growth in the U.S. national debt as an economic threat, are now expressing deep concern over rising interest costs. It’s a mixed bag of news: while analysts aren’t expecting the growth to worsen significantly, they are worried about the unfolding danger of rising interest costs. Unfortunately, there is little that can be done to prevent it. Even if the debt level remains constant, the added burden of higher interest rates could pose a significant long-term threat to the U.S. economy, according to analysts at both Goldman Sachs (NYSE:GS) and Wolfe Research.

Modest Improvements Overshadowed by the Inevitable

Analysts at Goldman Sachs told investors that the U.S. fiscal outlook is “not good, but a little better.” The respected Wall Street firm expects a modest improvement in the federal budget deficit, suggesting it shouldn’t balloon as much as previously forecasted. Their prediction is that it will finish the fiscal year at about $1.8 trillion. However, Goldman cautions that this barely positive news doesn’t address the underlying problem of low-rate debt maturing and the higher interest payments expected on refinancing that maturing debt.

The higher debt cost is difficult or impossible to avoid. Here’s an example that illustrates why: At the close of 2020, the five-year note was accruing interest payments for the U.S. Treasury to pay at about 0.35%. This five-year Treasury note matures in 2025. If the new interest rate in 2025 is similar to current rates, the refinancing will be at 4.50%. That’s almost 13 times the interest rate cost on the same-sized debt.

While the principal on the deficit (excluding interest payments) is expected to shrink, interest expenses are projected to reach a staggering $900 billion in 2024. This surge is largely due to maturing lower-interest debt being replaced with new debt issued at expected higher rates.

Source: St. Louis Federal Reserve Bank

The chart above tells much of the story: the increased cost of debt, as rates have returned from rock-bottom, has become a burden on various sectors of the U.S. economy. This includes corporate debt tied to treasury benchmarks, real estate markets, and equity markets that rely on the overall health of the economy.

An Unsustainable Trajectory

Wolfe Research takes a more critical view, emphasizing the “huge long-term downside risk” posed by the national debt. While recent government spending has fueled economic growth, they argue that the U.S. is on an “unsustainable long-term trajectory.” According to the Congressional Budget Office (CBO), publicly held federal debt is projected to reach an all-time high by 2029. Wolfe Research finds this situation concerning.

Key Takeaway

The national debt is a drag on the markets. Even if the debt level stabilizes, higher interest payments will strain the budget. This potentially hinders economic growth and hurts financial markets. Tools to address this problem are not in the Treasury’s toolbox, and the Federal Reserve doesn’t exist to help out on these matters.

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