Rising Treasury Yields Revive Fears About Soaring Interest Payments, Sustainability of Public Debt

A sign at a bus shelter shows the U.S. national debt, in Washington, D.C., on Jan. 20, 2023. (Mandel Ngan/AFP via Getty Images)

Stubbornly high inflation has kept the Federal Reserve on an aggressive rate-hiking path, driving up Treasury yields and borrowing costs, while reviving concerns about the sustainability of America’s nearly $32 trillion in national debt as interest payments rise.

Federal Reserve chairman Jerome Powell’s remarks on Tuesday and Wednesday before Congress—that the central bank might hike rates higher than previously expected due to persistent inflation—rattled markets and sent Treasury yields higher.

“The process of getting inflation back down to 2 percent has a long way to go and is likely to be bumpy,” Powell said in identically prepared remarks before the Senate Committee on Banking on Mar. 7 and the House Committee on Financial Services on Mar. 8.

While acknowledging that the Fed’s actions would dent the economy and bring pain to businesses and families, Powell said that the “historical record cautions strongly against prematurely loosening policy” and vowed to “stay the course until the job is done.”

Markets appeared to see the Fed chief’s remarks as a sign that monetary policy would get more aggressive and remain restrictive for longer.

Following his remarks on Tuesday, the two-year U.S. Treasury yield shot up 11 basis points, to 5 percent, for the first time since 2006. The 10-year Treasury briefly broke the 4 percent mark, and has been hovering not far below that psychological barrier.

The jump in Treasury yields, which are tied to interest payments on the government’s borrowings, have revived longstanding concerns about the sustainability of the national debt.

Interest Payments on Public Debt Up 38 Percent

The latest monthly budget review from the Congressional Budget Office (CBO), released on Mar. 8 (pdf), shows that the government’s expenses have grown while income has fallen—with higher interest payments on public debt being a huge factor.

Comparing the first five months of fiscal year 2022 to fiscal year 2023 (the Treasury Department’s fiscal years run from Oct. 1 of a given year to Sept. 30 of the following), outlays grew by 8 percent while revenues fell by 4 percent.

Higher Social Security benefits ($537 billion vs. $489 billion, or 10 percent greater) are a big factor. But a bigger one is net interest on public debt, which was 38 percent higher.

The reason the government’s interest rate payments (which are ultimately paid for by taxpayers) were $240 billion so far in fiscal year 2023, compared to $174 billion in fiscal year 2022, is because interest rates on all the various forms of U.S. government debt were significantly higher this fiscal year than last year.

“Treasury yields have climbed considerably over the last year, which means the federal government has been shelling out more and more just to service its outstanding debt,” William Luther, director of the Sound Money Project at the American Institute for Economic Research (AIER), told The Epoch Times in an emailed statement.

The explosive growth of the government’s interest obligations gives pause to those who worry about the sustainability of the public debt.

Imminent Crisis or ‘Much Ado About Nothing Scary’?

Discussions around the debt ceiling have dominated headlines, with a panel of experts warning in congressional testimony on Mar. 7 of a “catastrophic” blow to the U.S. economy if the country were to default.

This, in turn, has drawn attention to the problem of soaring public debt and whether it’s an imminent crisis or a slow-rolling calamity or—as some progressives contend—no big deal.

CBO director Phillip Swagel said in a recent statement that federal debt by the public is projected to rise from 98 percent of gross domestic product (GDP) in 2023 to 118 percent in 2033. That’s an average increase of two percentage points per year.

“Over that period, the growth of interest costs and mandatory spending outpaces the growth of revenues and the economy, driving up debt. Those factors persist beyond 2033, pushing federal debt higher still, to 195 percent of GDP in 2053,” Swagel said.

Swagel added that, over the long term, “changes in fiscal policy must be made to address the rising costs of interest and mitigate other adverse consequences of high and rising debt.”

Doeglas Holtz-Eakin, president of the American Action Forum, reached a similar conclusion—that continuing to add to America’s debt pile at the current pace is bad.

In testimony on the federal debt limit and its economic and financial consequences before the before the House Committee on Banking (pdf), he said the federal budget is on an “unsustainable trajectory, driven in large part by entitlement spending” and that lawmakers and the executive branch should address “this looming economic risk.”

Others, like Barry Eichengreen, professor of economics at the University of California, Berkeley, and the author of “In Defense of Public Debt,” say that concerns about an imminent debt crisis are “much ado about nothing scary.”

“Those who imagine an imminent debt crisis are making much ado about nothing. It would be better if U.S. policymakers saved their energy for fighting real rather than imaginary battles,” Eichengreen wrote in a recent op-ed.

Eichengreen argues that, while worth watching, the increase in America’s public debt is “by no means catastrophic” and distracts from pressing spending needs like reviving crumbling infrastructure or “averting a climate disaster.”

He says that America’s debt pile and interest costs aren’t too high so long as GDP growth outpaces real interest rates.

What that means is that with the interest rate (or yield) on the benchmark 10-year Treasury note around 4 percent and the CBO’s inflation projection over 10 years sitting at 2.4 percent, this puts the real interest rate relevant for the interest burden at 1.6 percent.

While “not a licence to engage in unlimited spending,” Eichengreen says that the interest burden remains sustainable as long as this 1.6 percent real interest rate over the next 10 years is lower than the GDP growth over that same period.

But with the CBO’s forecast for growth over the next decade sitting at 1.7 percent, the 0.1 percentage point difference doesn’t leave much room for error.

In his remarks to The Epoch Times, Luther confirmed the view that what is key for debt sustainability is the difference between GDP growth and inflation-adjusted interest rates.

“The debt burden does not technically become unsustainable until the real (inflation-adjusted) interest rate permanently exceeds the economy’s rate of long-run economic growth. At that point, the interest on the debt grows faster than the government’s ability to repay it,” he said.

‘Pretty Far From the Point of No Return’

Luther referred to a different measure as a gauge of interest costs on public debt, namely the five-year and 10-year Treasury inflation-protected securities.

“Trend real gross domestic product growth is in the neighborhood of 2.25 percent per year,” he said. “Treasury inflation-protected securities are currently trading at around 1.67 and 1.60 percent per year over the five- and 10-year horizons.”

“And even if those yields were to rise above the rate of long-run economic growth, the government would likely be able to weather the storm so long as markets expect the situation to be temporary,” he added.

“Fortunately, we are still pretty far from the point of no return,” he argued. “Of course, recognizing the precise location of a cliff is not a call to dance right up to the edge.”

“The closer the government gets to a yield-greater-than-growth scenario, the more likely bondholders are to abandon the government’s bonds in favor of safer assets,” he continued. “That reduction in demand would put greater pressure on real yields, making a default more likely.”

Luther added that while a default is “not imminent,” the rise in yields reflects an opportunity cost of government borrowing and serves as a reminder of the problem that big government borrowing crowds out private sector investment.