US Budget Projected Interest Rate Sensitivity Analysis: Quantifying The US Default Buffer

Tyler Durden's picture

It has long been discussed, both on Zero Hedge and elsewhere, that the massive budget deficit over the next 10 years will have to be funded with an unprecedented amount of new Treasury issuance. Various estimates project that absent a dramatic increase in yields, especially in the mid and longer dated side of the curve, there will simply not be enough demand for treasuries to fund the budget shortfalls just in the upcoming year (let alone the next ten). Furthermore, it is known that governmental estimates put early to mid 2011 total US debt estimates in the $14 trillion ballpark, courtesy of the just signed into law debt ceiling raise to $14.3 trillion. Lastly, the Treasury has made it well known that it intends to push debt issuance away from Bills and into Bonds and Notes, with the goal of increasing the average maturity of new debt to 5-6 years, which also would inevitably increase the average cost of Treasury borrowings as existing debt, of which 40% matures in under a year, has to be rolled into longer-dated debt. We present a recent monthly analysis of core Treasury receipts and outlays, highlighting the minor role that interest payments play currently. Yet should there be a dramatic or even gradual increase in rates, the monthly cost of funding of the ever increasing debt burden will soon become unbearable. A black swan scenario, which introduces an average interest rate reversion to those dark early 1980's days, when USTs carried interest of 10% and over, will see a 424% increase in monthly interest expenditures, which will push the annual interest expense as a percentage of core Treasury Deposits from the current 10% to nearly 50%, plunging America into a debt funding spiral.

First, we present monthly core treasury receipts and outlays. It should come as no surprise that over the past 18 months the Treasury has seen a net inflow based on core items just 3 times. For the purposes of this analysis we define "core" as Withheld Income and Employment Taxes and Corporate Income Taxes as the main UST receipt items, and Defense Vendor Payments, Education Department Programs, MedicAid and Medicare, Social Security Benefits, Unemployment Insurance Benefits and Interest on Treasury Securities as the main UST outlays. The chart below summarizes the progression of the composition of these core items since October 2008. We have yet to see a net inflow month since March 2009, primarily due to still collapsing tax receipts.

As can be seen on the chart above, the light-green shaded area, or the Interest paid on Treasury Securities, has been a minor portion of total UST outlays. The reason for this is the record low interest rate on Treasury Bills (we have experienced 4-week Bill auctions pricing at 0.000% on many occasions over the past several months), which comprise nearly half of all US marketable debt, the portion of debt which sees actual interest outlays instead of just intragovernmental cash flows, which is the case when observing the $4.5 trillion in various Trust Funds and Intragovernmental Holdings on the UST's books.

Focusing on interest payments, it becomes obvious that even as debt has hit all time record highs, the blended rate on LTM interest outflows has hit record lows. The chart below demonstrates the actual LTM cash interest paid over the past 28 months. As the trendline indicates, the prevailing interest payments have been declining!

Why is this perplexing? Because as the chart below highlights, the marketable debt holdings of the Treasury have been surging without pause to a January level of $7.8 trillion from $6.3 trillion in October 2008: a $1.5 trillion increase in marketable debt holdings in a little over a year. Yet, when calculating interest payment outlays on an LTM basis, and backing into what the implied interest rate on the marketable debt is, one sees the paradox: the as calculated interest rate on the surging debtload has declined from over 2.6% in 2008 to 2.2% presently.

The primary reason for this: the stable yields on the Treasury curve over the past year courtesy of the Fed purchasing not only $300 billion of Treasuries but also $1.4 trillion in MBS and Agency securities, which has kept the fixed income market calm since Quantitative Easing was introduced. Furthermore, the record curve steepness means that the Treasury is paying virtually no interest on 40% of its holdings. This spread divergence can be seen on the following FRB Atlanta chart:

So as we enter the stratosphere of debt holdings over the next 12 months and as we approach the $9 trillion marketable debt threshold by early 2011, what do rate assumptions tell us?

Well, if all is fine and good, and the Fed continues to monetize securities (USTs., MBS, etc.) past March, and over the next 12 months, there will be a constant bid under the "low-risk" Fixed Income complex. This means that the current blended rate of 2.2% will probably persist. Yet what happens if there is an interest flare event? What happens if not only Morgan Stanley is right and 10 years hit 5.5% (with 30 year MBS hitting 7.5%), but a feedback loop takes rates much, much higher, to those anathema days of Paul Volcker, when getting a loan below 10% was considered luck?

We present a table summarizing the probable outcomes below.

We believe the "Low" case is unrealistic as there is no way that an incremental $2 trillion in UST issuance will not move rates higher. Therefore we believe the Medium case is really the realistic downside rate case. In that case, the average monthly interest payment will increase from $14.3 billion to $24 billion: a 67% increase. It will also represent 16% of total Treasury receipts, compared to the current sub 10%. This is 6% that could be going to education, healthcare, defense or many other "core" programs.

Yet the scenarios that trouble us are the "High" and "Catastrophe" a/k/a Black Swan, cases. If MS is correct and 10 rates reach 5.5%, if the curve flattens, and if the UST manages to extend the average maturity well into the 5-10 year bracket, the 5% interest rate scenario is all too realistic. In this case, Interest payment will grow to an alarming 25% of all monthly receipts, while the average monthly interest outflow will reach $38 billion, a 162% increase.

Finally, if the low probability "Catastrophe" Projection Case comes through, Japan, here we come. Should prevailing Treasury rates somehow hit 10%, the average monthly interest outlay will reach $75 billion, a 400%+ increase from current outflows, and the Annual Interest expense as a % of LTM Core UST receipts will hit a stunning 50%! This means that the Treasury will spend 50% of all tax receipts merely to cover interest expense. And this assumes that the Trust Funds on the UST's balance sheet are not converted into actual outflow generating securities (more on this topic in a later post).

A full two-dimensional sensitivity analysis also takes into consideration the only real natural source of cash for the Treasury (aside from financings): tax receipts, both individual and corporate. We have demonstrated previously the dramatic deterioration in Treasury tax withholdings. The continued persistence of this trend is the single biggest nightmare for the Administration, as one can only finance budget shortfalls for so long, as tax receipts decline. The current combined LTM Treasury tax receipts (gross, not net of refunds) amount to $1.8 trillion. Should this number decline further, due to the administration's heavy handed approach in appeasing the electorate at the expense of the relevant tax payers (i.e, the richest 10% of the population which pays the bulk of the nation's taxes), and should increasing numbers of US taxpayers flee to overseas tax havens, there is legitimate case that should interest rates skyrocket, then the US Treasury could see 100%+ of all tax revenues going simply to cover interest expense. As anyone remotely familiar with economics or finance is well aware, this would be the end for America. In other words, we currently have a buffer of $400 billion in tax receipts declines, and about 10% in interest rate increases before America is officially bankrupt.

While the realistic outcome over the next 12 months will likely be between the Medium and the High cases, it implies that ever more tax dollars will have to be used simply to cover interest payments to both domestic and foreign creditors. And should the liquidity and funding crisis in Europe escalate, and the hatchling Black Swan migrate across the pond, causing a spike in Treasury Interest Rates, then what pundits lament about Japan's debt spiral will promptly be forgotten, as it becomes an all too real phenomenon not across the Pacific but here in our own country.

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Anonymous's picture


NoBull1994's picture

Presently, 25% of my portfolio is in the TBF.  If I had bigger nuts, and fully understood the ETF, would be 100%.

Shiznit Diggity's picture

You're betting against Hugh Hendry. Do you feel lucky?

BlackBeard's picture

I'll have the black swan please.  Plum sauce on the side.

IKEA Is Swedish's picture

And a cheap single malt scotch to wash it down.

perchprism's picture


Yesterday I added 12 bottles of Glenfidditch to my bugout stash under the house. 

WaterWings's picture

The 18 is like gold - you have to wait for the right customer, just like gold.

Also, imagine bugging out with X number of bottles...what if you run out of gas? Oh wait, you were planning on walking out of the city? Oh...well. That's all rather heavy. Gold and silver are quite portable!

Okay, really, no matter what you acquire it might as well be the most inexpensive, that you can store securely, without attracting attention. Sprinkle your stash with a couple of 18-year-olders for the sophisticates willing to pay...but forget the masses being able to appreciate the refined items. Cheap booze = silver. Rare scotch = gold.

Think volume.

sangell's picture

Thanks for the quantification of the disaster.

Anonymous's picture

10 yr yield will be at 4.5% in Feb 2011. Just a guess.

Reason one: deflationary forces will be introduced

Reason two: EU fears/flight to quality/jumping to frying pan into the fire

Reason three: QE simply pays off debt and fails to increase money supply

Anonymous's picture

If and when(and for unknown reason to us,yet known to the controllers of the market)the bond vigilante(and some hedge funds)"suddenly" find the US debt is unsustainable like the greek debt(why they all of a sudden remebered that in Jan when ZH was discussing it as long as I remeber),then the "run"on the US debt will start(or on the DXY). Now the question is when. In my opinion,only after enough retirement juice has entered the equity market will we see the market all of a sudden "remeber"that actually the US debt is unsustainable. Those of you who could come up with an estimate of timing for such an event,will be the next millioneers. Evey soverign will have their turn. Interesting and exciting times lay ahead....

bc0203's picture

I'd bank on a substantial portion of American retirement savings being tied up in government debt at some point before it's all over.


bc0203's picture

I'd bank on a substantial portion of American retirement savings being tied up in government debt at some point before it's all over.


Anonymous's picture

So would I. The fixed-income percentage
of ALL ASSETS in mutual funds is now
approaching (be still my heart) 30%!!!!
And that's all varieties of fixed income
(including junk) after languishing and
being inordinately and unprofitably
overallocated to equities for years.
Think about it. Despite all the blow
about heavy bond fund flows, it's just
now reaching 30% of total invested assets.
Nobody's learned a goddamn thing.

suldog's picture

+1   I agree 100%.  Confiscation.  And if the revolution has not started by then, that will do it.

DaveyJones's picture

I've never seen a horror film with graphs and charts before

Mazarin's picture

Great analysis...should be front page NYT, WSJ, WaPo. But of course, only here on ZH until it's too late.

Anonymous's picture

Who are you to disagree with Cheney?

Hephasteus's picture

Someone who can duck?

foxmuldar's picture

Definitely scary stuff. I'm betting Obama got wind of coming disaster he has helped create. Thats why he is now talking about tax increases on all of us. States are already rasing their rates on may items. Check your utility bills lately?  A third of the bill is taxes. Its going to get much worse. As Marc Faber says, Were all doomed.

Marc Faber on the US Debt Bubble:


IKEA Is Swedish's picture

"then the US Treasury could see 100%+ of all tax revenues going simply to cover interest expense"

...and the experiment in deficit economics will be over.

Until then, the Hendry vs Taleb contest will be a dandy.

Anonymous's picture

"We believe the "Low" case is unrealistic as there is no way that an incremental $2 trillion in UST issuance will not move rates higher."

Prepare to be amazed. The last two years has taught us that the widely accepted impossible can in fact become possible. You will see the same with rates.

I'll bet you have a better chance of seeing the Dow at 4,000 then you do of seeing the 30-year at 7%.

Anonymous's picture

Exactly Right!!! Just look to Japan for how long the impossible can continue. The unwinding of 53T in debt provides a lot of opportunity to fully monetize federal debt without causing inflation. The inflation has already happened. My guess is that the Fed will continue to play the inflation scare game and temporary QE program until the right worldwide crises environment comes along and the demand for dollars will allow for massive printing. Instantly, your federal debt problem goes away.

Personally, I don't agree with this approach as the banks should have been closed down and bad debt discharged but, given that the government and fed can't bring themselves to do the right thing, this is the most painless approach. As much as I don't care for Ben B, I think he understands all this very well.

Anonymous's picture


This analysis here is simply, very wrong.

Low rates do not decrease UST demand. See reality.

What else are you buying?

Comrade de Chaos's picture

an excellent article but:

"there will simply not be enough demand for treasuries to fund the budget shortfalls just in the upcoming year (let alone the next ten)."


it would be more accurate to say, there won't be enough of demand for treasuries at present low yields. The higher yields will spark the demand from baby boomers and especially pension funds given that the latest have to pay their obligations in dollars. However, the above will cause other negative consequences for example higher cost for corporate borrowings (let's say good buy to all good leverage is it ~ lowers the cost of capital / buyouts models, etc.)

Mark Beck's picture

Good presentation, but without buyers the interest rate is of a secondary concern. Can you attract enough T buyers to cover outflows with srinking revenue, without the FED QE2? This is our first hurdle. Then, as you very nicely presented, are the interest rate challenges for rolling old debt and selling new.

Obviously, the FED, when it should tighten, will be forced to roll over T debt it holds on the balance sheet. I do not see any real hope of tightening on MBS securities in FY2010. So for what ever payout, the FED will probably shift towards Treasuries, income on MBS reverse repos will not contribute that much to T buy momentum.

Now ZH has been covering the T buys very closely, which is a good first step. Step two would be to project when the T buy slack has expired, and the administration will start to posture for FED action. How will this be rolled out to the voters? Time is not on their side.

In listening to the president, it is clear that his only real hope of making it through his first term without a budgetary crisis was the health care bill, or as I call it a referendum on Medicare. He was hoping to reduce costs enough to buy him some time to extend beyond debt de-leveraging, but it did not happen. You can hear the frustration in his voice. He will be a one term president, and our economy will weaken steadily under the burden of debt. The US economic situation is extremely fragile. I would be surprised if we make it through CY2010 without a large negative economic trigger.

Mark Beck

Meridian's picture

He was hoping to get health care to tax for five years without providing any services so the money could be reallocated. Of course, as ZH so aptly has decribed in article after article, the outcome will be the same regardless.

SWRichmond's picture

Health Care "Reform" was, from the get-go, nothing more than a tax increase.  Obama's inability to pass it threatens the Treasury market's viability.  I think crashing the EU is Plan B.

RossInvestor's picture

One of the major problems in this analysis is the exclusion of any discussion on interest rate swaps which represents a large portion of the OTC derivative problem.  If interest rates suddently spike, JPM (by far the biggest player) will implode and the US financial system will collapse as the US's financial problems go exponential.

SWRichmond's picture

JPM will implode

that would be awesome

Anonymous's picture

Good analysis TD! Can you extend the table to cover the next 2, 3 and 4 year periods? I suspect that even with the low interest rate scenario (and definitely with the medium rate)the US will be bankrupt before Obama leaves office!

trav7777's picture

They should also chart the debt growth rate beyond that and overlay SS outflows onto it.

Within no more than a few years, half a decade at most, interest, which is now the #4 expenditure, rises to #1.  When your biggest outlay is interest on debt, you are bankrupt.

We're going to face the ugly side of the exponential curve as tax receipts flag and debt continues to double.  Another doubling of the debt, which should be accomplished in 8-9 years assuming its historical growth rate, will necessarily double interest expenses and this would place them above all other expenditures.

There are two ways out- print or default.  In either case, I do not want to be holding the notes of a bankrupt State.  We are already effectively borrowing to pay interest.  They must at some point seize assets plus effect brute force devaluation of the dollar

Yes We Can. But Lets Not.'s picture

"When your biggest outlay is interest on debt, you are bankrupt..."

OMG, I'm hugely bankrupt.


Blunt Instrument's picture

"When your biggest outlay is interest on debt, you are bankrupt..."


Nope.  When you are unable to fund the interest payments on your debt from income, you are bankrupt.

If your biggest outlay is interest on debt, you are likely overextended.  As long as you can fund it and afford necessities, you are still solvent.




bc0203's picture

Is anyone else concerned that the government keeps piling bailout "assets" onto its ledgers before it's big bankruptcy event?

Just sayin.

Anonymous's picture

We will be able to fund our growing cancer but it will be at higher interest rates, which will be the end of our bottom bouncing and down we go again. Can you even imagine interest rates 50 basis points higher and what that would do to the fragile, imploding housing market. Forget jobs. They are gone.
It is soon....over.

monopoly's picture

We will be able to fund our debt this higher interest rates. Can you imagine what even 50 basis pt. higher treasuries will do to our mortgage market. Housing will continue lower, we will stop bottom bouncing and start the next leg down and forget about jobs. There won't be any quality jobs. Sure, 8,9,10 bucks an hour might work. But a job where you can support your family and hold your head high.

Its over.

fotokemist's picture

re: choice to either default or inflate:  Don't underestimate the probability of military action, either overt or covert.  It is unlikely to be a good strategy for a country (or its leaders) to give the US PTB too much grief.

primus's picture

We're already there! We're a superpower-in-name-only!

The US military is the only thing holding the entire Ponzi-fraud swindle stitching together as it is!

Do you really think the red Chinese would be 'loaning' the USA subprime degenerate debt junkie money at 0.000% if we didn't have fleets of aircraft carriers prowling the Pacific Ocean and every other nasty military toy that bites shipping out to Iraq and Afghanistan?

Our feckless government, weather it knows it or not, is counting on unemployment at 25%. It is the only way to boost enlistment to the war machine and keep the mirage of 'America: Shining city on the hill' alive.

Forget about Medicare and SS reform. We might have been able to save them 25 years ago, but instead decided to invest in 'Star Wars' and red baiting. The best thing you can do for your country - and it's corporate masters - at this point is enlist or drop dead before filing for unemployment benifits.

Anonymous's picture

You are not bright.

If the Chinese "stopped loaning us money" they would instead spend that money to buy things from the US.

This means either asset prices would rise (stocks, real estate, commodities) or workers would be fully employed (making Boeing Airplanes, Trucks, Turbines, iPhones).

Niether of those sounds very bad.

Anonymous's picture

As a grown-up during the late 1970's and early 1980's, I can tell you that when Treasury yields hit double digits it's because the Fed allows them to, and by that time you're already in a world of hurt.

The primary reason that inflation rose well into double digits during the late 1970's was because the economy was struggling with oil crises and rising unemployment leading the Fed to be afraid to allow (let alone force) interest rates to become higher than the rate of inflation - which was definitely rising. Just as right now we hear from the majority of economists "It's too soon to raise rates, because that would stifle any sustainable recovery and give us a double-dip recession", back then the formula was "It's untenable to raise rates very much, because that would trigger another recession (like the nasty one of 1974) and send unemployment through the roof."

The result was interest rates perpetually lagging inflation, lots of wasteful speculation (oil and PM got crazier and crazier, and high yield Latin American loans were really popular with the banks - the crash of which gave us the Great Bank Bailouts of the 1980's). Treasury yields were rising, but never fast enough to catch inflation. When Volcker became Fed chair he could easily see that a race between inflation and interest rates, with interest rates always lagging, was actually a CAUSITIVE element of ever-rising inflation (in the midst of commercial stagnation, no less! A revolutionary, and then-controversial, insight) by forcing capital away from stable investments into pure speculation in rapidly inflating assets.

We all know the outcome. By raising interest rates well above the rate of inflation, a recession was forced as borrowing came to a halt in investment as well as speculation, and deflation exploded all over the crazy assets. Unemployment and bankruptcies went to levels not seen since the Great Depression, and Volcker was called some real bad names. Most importantly, the fall in the value of speculative assets was much faster and farther than the fall in the value in stable investments, and for the next 30 years we had the luxury of steadily declining interest rates to power a credit-based boom (eventually mislabeled "The Great Moderation" - as if things like the bringing on-line of new oilfields in Alaska, Mexico, the North Sea and Nigeria had nothing to do with the falling of the cost of energy and hence of inflation).

For the first fifteen years after 1982 the mantra was "Now we've learned that inflation must be kept in check BEFORE you have to crush everything with astronomical interest rates." Then Greenspan and his heirs became cocky as the destruction of unions and the growth of offshoring and of the internet balanced accelerating credit expansion, so that inflation was considered a fluke of ancient history from back in the day when people were stupid (as were speculatory credit crashes).

Now, here we are again beset with a Fed that is afraid to trigger economic contraction by allowing sufficiently high real rates, and the only way you will see double figure Treasury yields in the foreseeable future is if speculation runs up inflation to double figures first. That's a promise.

bokapita's picture

Superb analysis, rooted in actual physical economic output data. Total applause, for it is easily lost sight of that finance, per se, is meremy a secondary effect of the physical reality it rests ultimately upon.

Anonymous's picture

Yes, yes, yes. You have nailed it. The real problem is a lack of will to strike now and endure the pain rather than sit back and hope it somehow goes away.

I mean, it's possible that all the foreign debt holders will simply smile and surrender their notes because they like us, right? It could happen, right? And wind power will come on line in June, right? What am I worried about?

jplotinus's picture

Excellent and helpful comparative analysis.  Thanks.  One difference between now and the '70s though is the different way of calculating inflation.  I wonder what the current rate of inflation would be if based on the same formula in use in, say, 1979?

D.M. Ryan's picture

John Williams of Shadow Stats has a chart of what it would have been:

Anonymous's picture

An old CPA that I used to work with (he's now 87 and still going strong) told me once how to understand what the real rate of inflation is (because the gov't stats were a lie): look at the price of basic goods or services many years ago vs. now, and plug it into a formula to get the annual rate. The examples he used were a first class postage stamp and a NYC subway token, which were $0.03 and $0.05 in 1945. When we discussed it in 1995, these were $0.32 and $1.50, respectively, which gave us inflation rates of 4.85% and 7.04%, respectively. OK, we really need more items to determine the rate across the economy, but in any case the official rate of inflation over that period was 4.36%, under both of the examples (and even a little bit under means a big difference after 50 years).

FYI, with postage now at $0.44, the inflation rate on that for the last 65 years is 4.22%, vs. 3.85% for the official CPI.

I invite anyone here to do the same for college or housing costs, automobiles, medical services (as much as they can be compared to those at some point in the past) or any other item or service commonly used by people. You'll almost certainly come up with the same result (with the big exception of anything involving computations or information - that is the one item that has come down in price dramatically over the years (and will continue to do so for a while), but it is a relatively small percentage of the economy and therefore has a relatively small impact on the overall rate of inflation.

They're lying to us - common sense and some very basic math tells you that.