August 22, 2023
We’ve been asked many times over the years if the level of US debt matters. Our response has always been, “Debt levels matter when they matter.” However, following Fitch Inc.’s recent downgrade of US government debt, one must ask if we are getting closer to the point where it matters.
The federal government has seen an increase in outstanding debt every year since 2001. The ratio of outstanding debt to gross domestic product (debt-to-GDP ratio) is close to 100% and was only higher around World War II. The Congressional Budget Office (CBO) forecasts that the debt-to-GDP ratio will increase rapidly over the next decade, easily eclipsing the 1946 high of 106%. Rising debt levels haven’t been an issue in an environment of falling interest rates. However, as we noted a couple of months ago, we believe that we are entering a period of higher inflation and therefore higher interest rates. Interest expense for the US government is expected to rapidly increase over the coming decade and is projected to be larger than defense spending and non-defense discretionary spending within 10 years. The chart below shows that interest expense is already rising rapidly when compared to government revenue, and the share of interest to revenue is now the highest in nearly 25 years.
As interest expense on federal debt absorbs an increasing share of the budget, policymakers may have to make some difficult decisions. Do they raise taxes, cut entitlement spending, cut defense spending, cut non-defense discretionary spending, or some combination of all these? Do they allow debt to continue to grow relative to the size of the economy until something breaks? The latter choice could be risky, given that the two largest holders of US Treasury debt, the US Federal Reserve and non-US residents, are actively selling their holdings. The choices that need to be made could have significant investment implications, affecting economic growth, inflation, corporate profitability, consumer disposable income, and the value of the US dollar. No one can predict when debt levels will matter. However, we are becoming more concerned about the negative fallout from these trends.
US government interest expense as a percent of total revenue
Monthly data: January 1, 1962–July 1, 2023
Note : Shaded area on chart indicates a period of recession
Sources: Macquarie , Macrobond, US Department of Treasury, and US Congressional Budget Office (CBO).
Chart is for illustrative purposes only.
Inside the markets
Chart-powered guide with macroeconomic perspectives and insights on the markets