Every January, firms throughout the financial industry, including our own, hold annual training meetings or conferences. One of the highlights of these meetings is an award for salesperson or sales team of the year. These titles are hard-earned and well-deserved. At least for our own firm, I can say that the winners are always those who, not only achieve impressive revenues for the firm, but do so through very hard work, understanding the investment environment and, most of all, understanding the needs of our clients.
But with all due respect to my colleagues, no one in 2023 had a sales year that came anywhere close to that of Janet Yellen and her minions over at the Treasury Department.
Last year, they achieved net sales of Treasury debt of $1.86 trillion—the second highest total ever. This allowed them to not only finance a massive federal budget deficit but also to stash an additional $360 billion into their checking account at the Fed.
Moreover, they did this in the face of still high inflation, the rising expense of foreign conflicts, threats of government shutdown and default and being put on a ratings agency downgrade watchlist. In addition, despite aggressive Fed tightening and a lot of volatility during the year, they were able to finance their long-term debt at essentially the same rates at the end of the year as at its start. And, remarkably, they achieved all of this while their biggest customer was redeeming their bonds at a pace that would rival the “returns” line in Costco on the day after Christmas. Indeed, their net sales to U.S. and international investors, outside of the Federal Reserve, amounted to $2.56 trillion, up 63% from a year earlier and 22% higher than the previous record set in the pandemic year of 2020.
Rising Debt Worries And Offsets
All of this, of course, says more about the appetite of global investors for U.S. Treasuries, that it does about the marketing skill of the Treasury Department. And this demand should, to some extent, calm fears that rising federal debt will soon lead to surging long-term interest rates.
Clearly, there are reasons for concern about rising federal debt. In their 10-year projections last May, the Congressional Budget Office, or CBO, estimated that annual deficits would climb from $1.4 trillion in fiscal 2022 to $2.2 trillion in fiscal 2033, with the debt-to-GDP ratio rising from 97% to a record 119% over the same period. Importantly, however, these forecasts included a significant underestimate of the 2023 budget deficit and also, by convention, assumed that the 2017 tax cuts would not be extended beyond 2025.
If we adjust these forecasts for the part of the CBO forecast error that is likely to persist and we assume that the 2017 tax cuts are, in fact, extended, the math gets even more worrying, with federal debt in the hands of the public on track to reach $50 trillion by 2033 or 127% of GDP.
However, even on this sobering path, there are important offsets that could limit any increase in long-term interest rates, at least in the near term.
First, even if the economy continues to grow over the next few years, the Federal Reserve will have to wrap up its quantitative tightening program in order to allow its “ample reserves” regime to continue to operate. Since the Fed is currently reducing its Treasury holdings by up to $720 billion per year, this would significantly reduce the government’s need to borrow from other investors. If the economy were to fall into recession, the Fed might resume its quantitative easing program, further reducing Treasury’s need to borrow in the open market, although a recession would obviously strain the budget in other ways.
Second, primarily because of Fed tightening, net interest costs for the federal government have soared from $350 billion in fiscal 2021 to $660 billion in fiscal 2023 and likely close to $900 billion this year. Aggressive Fed rate cuts, in the face of recession or even persistently low inflation, could reduce this cost very substantially.