Debt: Hard to Handle

Interest expense is a large and growing issue for both the economy and stock market, which reinforces why investors should stay up in quality amid interest-rate-driven headwinds.

One of our expectations highlighted in our 2023 outlook report, published in late 2022, was that the subject of the U.S. budget deficit and federal debt would increasingly become a part of the "conversation." That has certainly been the case—heightened recently, courtesy of the runup in longer-term Treasury yields. In today's report, we'll focus on the government and corporate sectors, with a focus on consumers to come in later reports.

Fiscal follies

The federal budget deficit is estimated to be about $1.7 trillion for fiscal year (through September) 2023, which is more than 6% of gross domestic product (GDP) and compares to $946 billion for fiscal year 2022. That has brought total federal debt to more than $33 trillion.

Since the start of this century, per Gavekal Research data, U.S. government debt has increased by a factor of more than 5.5, which is an annual growth rate of 7.7%. That's in contrast to GDP and debt-servicing costs, which have increased by a factor of "only" 2.7, equating to annual growth rates of 4.3% and 4.4%, respectively.

The lower rate of annual growth in debt-servicing costs was aided by the Federal Reserve's three significant monetary policy easing cycles—the latter two, starting in 2008 and 2020, saw short-term rates hit the zero-bound. Those were also cycles that included quantitative easing (QE), which helped restrain longer-term yields.

Now the Fed faces government debt that's larger than GDP, debt that needs to be financed at higher rates, and a debt service ratio growing much faster than the economy. In addition, the Fed is now reducing its holdings of Treasury securities with its quantitative tightening (QT) program; while foreign investors, U.S. banks and state/local governments are reducing their holdings.