In the days before the Memorial Day weekend, rates on 30 year Treasury bonds hit their highest level in 19 years at 5.2%, and the benchmark 10-year reached 4.7%, the top reading since mid-2007. If those kinds of yields take hold, the scenario for federal interest expense posited in the CBO’s “Budget and Economic Outlook: 2026 to 2036,” released in February, descends from dire to near-disastrous. Takeaway: America’s track to fiscal safety has lost all margin for error, and nothing demonstrates that better than the long-term impact of loftier than expected rates. America’s got so little room to maneuver that even yields that modestly exceed the CBO’s “baseline,” as the numbers compound in the years ahead, deliver a huge extra blow by crowding out big chunks of revenue that would otherwise go towards funding such essentials as Defense, Social Security and Medicare.
The CBO forecasts that yields on the 30 and 10-year Treasuries will respectively average about 4.65% and 4.15% through FY 2036. That’s roughly 55 basis points lower than the multi-year summit briefly notched in late May. Doesn’t sound like much of a difference, right? And if the interest expense on our gigantic and ballooning national debt of $39 trillion weren’t already running at nearly $1 trillion a year, bigger than Medicare spending and equaling two-thirds of Social Security outlays, the half-point upward shift would likely prove manageable.
But a recent report from the non-partisan Committee for a Responsible Federal Budget quantifies the deep damage even a continuation at the recent peaks would inflict. By 2036, interest expense would jump from absorbing 14% of all revenues to devouring 30%, five points more than under the CBO’s forecast. At $2.5 trillion, 2.5x today’s number, the carrying costs would become the second largest budget category, beating Medicare by one-third. Interest cost per household would soar from $7,900 last year to $17,000 a decade hence.
Much of today’s extreme vulnerability to even slightly higher rates arises from the need to both refinance existing debt, and shoulder trillions more in newly-issued bonds to cover deficits, at much higher cost. All told, the federal government will need to borrow almost $10 trillion in the next 12 months, equivalent to one-third our total debt. That amount consists of around $7.5 trillion to repay the Treasuries coming due, and $2 trillion for plugging the shortfall between revenues and spending. A major reason the U.S. accumulated so much debt in the first place was the lure of ultra-bargain yields orchestrated by the Fed’s easy money policy during and following the COVID crisis. In 2021 through early 2022, Treasury Bills, instruments that mature within a year, offered around a minuscule 0.2%. Today, that cost’s 18 times fatter at 3.7%.
Rates have also climbed for the Treasury Notes running 5 to 30 years that account for over half of all federal debt outstanding. Because we could borrow so cheaply for so long, the average rate on the Notes stands at just 3.23%. But the U.S. is refinancing the bonds that roll off for a lot more, 5.2% on the 30 year as of just before Memorial Day, and 4.7% on the 10-year.
In fact, the borrowing blowout that got the U.S. in so much trouble resembles the rush into “teaser” home loans in the 2007 runup to the housing meltdown; folks fell for temporary, super-low “teasers” rates that when they reset higher, saddled the borrowers with monthly payments they couldn’t afford. A similar dynamic’s at play as the U.S. refinances low-yielding Treasuries issued when it looked like a deal to finance huge government spending—at today’s much higher rates.
As of May 26, news that the Iran War may end soon pushed yields for the 30 and 10 year down slightly, so that they’re now sitting around 35 basis points above the CBO forecast. Still, the threat they’ll bounce back to the half-point-plus margin that’s so scary raises a stern warning for the new Fed chief Kevin Warsh. It’s encouraging that Warsh publicly favors tightening monetary policy by lowering the immense holdings of Treasuries on Fed’s balance sheet, a policy that involves unloading a big portion of its portfolio to the public. That gambit transforms trillions that would otherwise be spent into savings.
The Fed balance sheet shrink would also shrink what’s causing the problem: Extremely high “aggregate demand” across the economy that sends too many dollars chasing a volume of goods that’s growing far more slowly. (Noted economist Will Luther described this phenomenon in my recent story.) Warsh can also raise the Fed Funds rate, or even announce he has no plans for a reduction, to cool the still relatively-plentiful credit that’s fueling big spending by consumers and of course, humongous outlays for AI data centers. But the primary reason aggregate demand’s way too high is excessive levels of government spending that if left unchecked, could lead to even higher rates than the peak numbers that just unleashed such a jolt. Warsh can help by lifting the cost of credit to throttle both consumer and corporate spending, and sell bonds the Fed’s holding to target the latter. But he can’t control the big one, the runaway federal budget.
That responsibility falls on the President and on Congress. As the CRFB states in their analysis on the impact of rising yields, “The best way to accomplish these goals is through deficit reduction, which can help the Federal Reserve lower rates by reducing near-term inflationary pressures, put downward pressure on long-term rates by reducing economic crowd-out [that diverts money needed for budget must-pays to interest], and reduce the debt burden on which the government must pay interest.” The CRFB adds that yields that hang in the pre-Memorial Day range or push higher threaten to “spark a fiscal crisis.”
Nothing better illustrates that AMERICA IS BROKE than how an increase in yields that wouldn’t seem to matter much in most times could spell a cataclysm now that our fiscal state’s so fragile. Neither party wants to talk about how broke we really are, or do much to address the problem. Unfortunately, it may take an outbreak of unaffordable interest rates to force our lawmakers into facing the peril of their own making.
