The debt structure in the US is quite substantial, with $26 trillion in market debt across various types of treasuries.
Impact on Various Bond Markets
Now, the rates on medium and long-term treasuries are at their highest level since 2007, but:
- First, as a benchmark, Treasuries affect interest rates on all types of bonds, including high-quality corporate bonds. Not to mention junk bonds, whose yields have soared into the stratosphere. This increases the cost of debt service for everyone.
- Second, tiered Treasury bond redemption schemes can lead to "breakage" of weaker links in the chain, such as investment banks and hedge funds, which can lead to a cascading collapse of assets as a result of collateral enforcement.
- Third, public debt was only $4.2 trillion in 2007, and the average annual net borrowing requirement during the period of high interest rates from 2005 to 2008 did not exceed US$300 billion on budget revenues of $2.4 trillion. At that time, high interest rates were not so critical.
Future Financial Challenges
Now, to make ends meet, at least $2 trillion a year would have to be withdrawn from the market on a $26 trillion debt and $4.5 trillion in revenues. This will be even more difficult as interest costs rise by $200 billion a year and defense spending will have to increase by at least $100 billion to $150 billion.
A budget deficit of $2.3 to $2.5 trillion in 2024 should not come as a surprise.
The problem is that there is no margin of safety. Bills have been financed since June 2023 through the "unwinding" of the reverse repo with the Fed, which has shrunk by $1.2 trillion, leaving just over $1 trillion remaining.
Now, the Ministry of Finance has $0.82 trillion in cash, and by the end of the year, net placements will be no more than $0.3 to $0.4 trillion, which aligns with my May estimates.
Additionally, the Fed is selling treasuries at a rate of $60 billion per month. In total, the overhang of the supply of treasuries is estimated at $3 trillion per year. This does not include refinancing, which accounts for over $8.5 trillion a year, with $5.5 trillion being in bills.
The volume of national savings of the population is less than $1 trillion, and not all of it goes into treasuries. Non-residents can intercept no more than $0.2 to $0.3 trillion per year (actually less), along with the same amount from insurance and pension funds. The financial sector, in aggregate, will add a maximum of $1 to $1.3 trillion.
All this means that closer to May 2024, "the system will start to unravel" as the imbalance between supply and demand becomes significant. Accordingly, we should expect radical actions on the part of the Fed.
It is likely that in early 2024 the asset sales program will be canceled, and closer to the middle of 2024 it will be necessary to launch QE or introduce austerity measures in the budget.
Conclusion
In summary, the United States faces a monumental challenge in managing its $26 trillion debt structure, especially with interest rates on medium and long-term treasuries reaching levels not seen since 2007. This situation has wide-reaching implications, affecting not only government finances but also reverberating throughout the broader financial landscape, from corporate bonds to riskier assets like junk bonds. The growing budget deficit, coupled with limited safety nets, necessitates critical decisions and actions in the near future.