Investors start to fret about ballooning US public debt

Last month, as the US midterm elections approached, Deutsche Bank analysts released a calculation that should have made American voters wince. It shows that the US government currently pays $1.43bn each day (yes, day) to service its public debt — 10 times more than any other G7 country (Italy is a distant second in this grim league).

This is striking, even allowing for the size of the American economy. But what is doubly thought-provoking is that this $1bn bill has materialised when interest rates are still fairly low by historical standards. And that invites a crucial question for the US Congress: what will happen to that debt, and servicing costs, if (or when) interest rates climb to a more normal level?

Until recently, neither investors nor voters seemed to care particularly. After all, asset managers have flocked to buy US treasuries in recent years, even as America’s debt pile swelled above $15tn. And those once-feared bond vigilantes seemed all but dead last year when President Donald Trump’s government announced massive tax cuts, further increasing debt.

But markets are getting more twitchy. Consider what happened during this week’s midterm elections. As the results tumbled in on Tuesday night, bond yields jumped whenever Republican candidates gained an edge. However, those yields fell back as the polling map turned blue, and Democrats took the House of Representatives.

An optimist might simply blame these swings “just” on a perception that the Republicans are more growth-friendly. Indeed, Larry Kudlow, White House economic adviser, recently told the FT that the main reason why long term US yields had edged up this year — aside from tightening by the Federal Reserve — is that investors love the economic expansion that has been unleashed by Republican tax cuts. And he dismissed the idea that these are creating a fiscal threat, arguing that America should be able to “grow out” of its debt in the long term.

But another way to interpret this week’s swings is that some investors are finally becoming so uneasy about the fiscal stance that they hope that a Democrat-controlled House will clip Mr Trump’s wings. And it is easy see why those investors might be starting to fret.

Consider again that daily debt servicing number. According to the Congressional Budget Office, the total annual cost of net interest payments on American debt in 2018 will be around $318bn. Right now, that sum seems manageable, relative to the overall American budget.

But the CBO calculates that servicing costs will triple in size to nearly $1tn by 2028, on current policy trajectories and assuming that interest rates rise towards their long-term average of 3.7 per cent and 2.8 per cent for 10-year bonds and three-month bills respectively (or slightly above the current levels of 3.2 per cent and 2.34 per cent).

If so, interest payments will soon become the third biggest item on the budget, eclipsing even military spending. However, if interest rates rise faster than the CBO expects, the picture would be worse. For another striking feature of American debt is that its average maturity is only six years, shorter than most European countries. And during the Trump administration this maturity has — lamentably — shortened.

Before the election, for example, the US Treasury quietly revealed that the deficit is poised to top $1tn for the first time in history. To plug this gap, Steven Mnuchin, the US Treasury secretary, plans to sell $83bn of bonds, which is also a record, eclipsing even the level of bond sales after the global financial crisis. Strikingly, Mr Mnuchin predicts that almost half of this tally — some $37bn — will have a maturity of just three years. This short maturity makes the debt more prone to rollover risks.

So is there any chance of the White House changing course and starting to tackle these risks? Don’t bet on it. Although a Democrat-controlled House can probably prevent more tax cuts, a large-scale policy rollback seems unlikely.

But if Mr Trump really wants to “collaborate” with the Democrats — as he claimed on Wednesday — a great place to start would be to look for some bilateral debt-reducing strategies.

Better still, why not create a new version of the bilateral Simpson-Bowles Commission, which proffered some sensible ideas under the last administration? This does not necessarily make for thrilling headlines, but it is what American voters and investors desperately need — particularly with the Fed still determined to keep raising rates. Let us hope someone shows the president that eye-popping $1.43bn daily debt bill — and then urges him to act. — Financial Times