Federal debt periodically raises its head as a political issue for Americans. In 2011 and 2013, lawmakers tangled over the raising of the Federal government’s debt ceiling; but deficits have not galvanized the American political imagination for some time.
That’s because the accumulation of debt has been slowing, and interest rates have been at historic lows. In that environment, the issue of government debt has largely been sidelined.
Source: Federal Reserve Bank of St Louis
As the figure above shows, after a spike during the recession, the growth rate of Federal debt has slowed dramatically -- and at the same time, borrowing costs have cratered. Altogether, a swell deal for the U.S. fiscal situation.
The fly in the ointment, of course, is that it can’t stay this way forever. Interest rates will rise, and the outlays necessary to service debt will rise as well. According to the analysis of the Congressional Budget Office, we note, an interesting event will occur in 2022: outlays for debt service will exceed defense spending. That might cause lawmakers to sit up and notice.
Source: Congressional Budget Office
In absolute terms, between 2015 and 2025, Federal outlays will increase by $2.5 trillion:
Source: Congressional Budget Office
A quarter of the increase in Federal outlays will come from increased debt service payments.
These effects will be gradual. However, it will not just be private citizens and corporate America who will be learning to deal with the end of a 30-year interest rate cycle; the Federal government will be challenged as well. We predict that budget issues will once again come to the fore in coming years -- and we predict that the economic drag of the Federal government’s increasing debt service burden will become more problematic.
Investment implications: In the next several years, Americans will begin navigating the slow reversal of a multi-decade cycle that has seen interest rates reach historic lows. The Federal government, which has grown used to shrinking deficits and low debt service outlays, will find itself squeezed as deficits and debt service grow.