What is wrong with this picture: the MTS just announced that the February budget deficit was $220.9 billion, after receipts of just $107.5 billion with vastly surpassed by outlays of $328.4 billion. This is a record. Yet the interest on the public debt was a mere $16.9 billion (page 13 of the MTS report). The reason for this is because as TreasuryDirect points out, in February the interest on public marketable debt (actual cash outlays), which as of Monday stood at $8.061 trillion, hit an all time low of 2.548%. How is it possible that unprecedented debt accumulation can result in ever declining interest rates, and Treasury auctions, such as today's 10 Year reopening, in which the Bid To Cover hit an all time high? One answer: The Federal Reserve, which through complete domination of the entire capital market courtesy of ZIRP and QE has now turned market logic upside down by 180 degrees. In a normal world, the more money you borrow, the greater the associated risk, and the greater the interest payments on this debt. Not in America though. So can we assume that the Fed can forever keep rates on debt at record low levels? No. Which begs the question: what happens when interest rates do finally start going up?
Here is the relevant page highlighting the deficit. In a word: the US collects enough money organically (via taxes) to cover less than a third of its outlays.
A look at the distribution of receipt components should lead to questions about the sanity of anyone who claims that the budget trajectory is sustainable - in a word, tax revenues are plunging. Of course, this has to be evaluated in parallel with the observation that tax refunds in January and February of 2010 have actually surpassed those of 2009 as Zero Hedge discussed previously, explaining why consumers have shown abnormal resilience so far in 2010.
So even as the income side of the Federal ledger has rarely if ever been quite as bad, the expenditure side has exploded, and not as a function of debt funding: the bulk of outlays have to do with entitlement programs which came in over $160 billion, and which still could not have been covered organically.
Here is where debt comes in. We know that recently the debt ceiling was raised to $14.3 trillion which is expected to be hit in less than a year. Observant readers will recall that the previous ceiling of $12.4 trillion was supposed to last the US until the end of March - well, not only was this number passed over a week ago, it is now, less than half way into March at $12.5 trillion, which would have broken the debt ceiling far in advance of expectations. This leads us to believe that the $14.3 trillion ceiling will likely have to be raised once again and at a very critical time for the administration: around mid-term election time.
Yet if one were looking just at the interest rate paid by the government on the marketable debt portion of the public debt (which was $8.06 trillion as of most recently), it would appear that America's economy was cranking on all cylinders. Of course, this is not the case, and the rate is merely an indication of the Fed's direct intervention in all possible markets.
The chart below shows the absolute level of the interest on marketable debt, and the MoM % change. In February the rate came in at a record low 2.548%, a 1.8% decline from the 2.595% in March.
To be sure, this is expected with the Fed running a Zero Interest Rate Policy, and QE adding direct purchases by the Fed.
Yet what is notable is that even with the effective Fed Funds rate at zero for over a year, the rate on marketable debt has bottomed out, and the spread from FF to the Interest Rate has held constant at about 2.5%.
The primary reason for this is the duration distribution of US debt. The short-term portion has already reaped the benefits of issuance at or near 0%, while the longer-dated side of the curve is keeping rates higher. If indeed the Treasury is serious about extending the average maturity on public debt from 4 to 6 years, the new baseline for this spread will eventually be at about 3%, where it was earlier in the decade.
Yet the logical next question is what happens when rates start going up? It was as recently as September 2007 that we had a interest rate on marketable debt of nearly 5%. The plunge to 2.5% took just over a year. Even the mere mention of actual tightening will spring rates right back to 5%. What does that mean for actual outlays. Well: if indeed we are correct that total debt will hit $14.3 trillion in less than a year, it means the marketable debt will be about $10 trillion, and the incremental 250 bps of interest will mean about $250 billion of additional interest outlays a year, or half a trillion annually. That comes to about $42 billion a month. In January this amount would have been double the net withheld income taxes.
It becomes obvious why the Fed simply can not allow rates to go up. It has nothing to do with excess liquidity, which of course is a major concern as America goes from one excess-liquidity bubble to another. The problem is that the surging budget, which will need ridiculous amounts of debt for funding, will truly explode if rates were to go up merely to 5%. What happens if rates hit 7.5%... or 10%? At that point it is game over. And that sad ending will occur once the Fed and the administration realize that all ongoing efforts to kick start a consumption driven economy will fail. In the meantime, the economy will slowly grind to a halt as the servicing of public debt takes over a greater and greater portion of all tax receipts, until all taxpayer money is used merely to cover the interest expense. At that point buying CDS on the US denominated in euros, dollars, gold, .556, watermelons, or what have you, will be completely pointless as the bankruptcy of the US will be entirely priced in.