Janet Yellen Bets $2T that Rates Will NOT be Higher For Longer
A Major Trend Change
In 2023, the Treasury added $2.6T to the national debt. While that number alone should be enough to scare anyone, the details reveal something even more concerning. $2T of it, or 77%, was financed entirely with short-term Treasury Bills maturing in less than a year. The chart below shows the debt issuance trend over the last 20 years. As shown, the Treasury typically relies on medium-term debt (2-10 Year Notes) to fund the budget deficit. 2023 was a massive change in standard procedure as shown by the giant light blue bar on the right of the chart.
Figure: 1 Year Over Year change in debt
The only other times Bills were used as a primary funding source were in 2008 during the Great Financial Crisis and 2020 during Covid. Neither year came close to 77% of total new debt issuance. These were also emergency times, and specifically in 2021, almost half the short-term debt was retired in favor of Notes and Bonds to undo the 2020 Bill issuance.
The Treasury has spent nearly two decades trying to extend the maturity of the debt. This can be seen in the blue line below which shows the average debt maturity. When short-term debt is issued in such a way, it drives down the average maturity, which causes the Treasury to have to roll over more debt in shorter periods. So why has the Treasury all of a sudden gone entirely to short-term debt in non-emergency times? The answer lies in the orange line, so let’s dig in.
Figure: 2 Weighted Averages
First, it is important to understand the interest rates the Treasury is facing. The chart below shows the current yield curve as it stands today and 6 months ago. As you can see, short-term rates are a full 1%-1.5% higher than medium-term. What?!? Didn’t we just see that the Treasury has specifically targeted short-term debt?
Why are they paying more than they have to? Had the Treasury financed the $2T with Notes, they would have saved $30B in interest this year alone!
Figure: 3 Tracking Yield Curve Inversion
So, why have they done this? Well, there are two potential possibilities.
First, they may be nervous about the market’s ability to handle so much medium-term debt. The market typically digests short-term debt very easily, but it can become saturated with medium-term debt. The chart below shows the amount of medium-term debt that rolled over last year. This is not new issuance; this is debt maturing that needs to be rolled over.
As shown, nearly $2T rolled over last year. This means that had the Treasury issued Notes instead of Bills, the Market would have had to absorb a whopping $4T in new medium-term debt like they did in 2020. The difference this year is that back in 2020 the Fed bought nearly all of that debt, putting a floor under the market.
Compounding this problem further is that this year is set to be a record year in terms of debt rollover. Nearly $2.9T in Notes need to be rolled over.
Figure: 4 Treasury Rollover
Still, even with that massive amount of debt issuance, there must be more to the story. Why would Yellen specifically pay $30B more in interest just because she is concerned about the volume of debt issuance? As Figure 1 above shows, this has never been a concern in the past except in emergencies. Furthermore, why not issue at least some new debt as medium-term.
This lends to a second and more probable conclusion. Long-term rates are set to fall in the very near term. The Treasury did not want to lock in for 2-7 years at 4% if it knows rates will fall. It will pay a premium ($30B this year) if it means it can lock in lower rates for longer and save money on the back end.
So, why are long-term rates, going to fall? Because they have to… the chart below shows the current interest owed on the national debt annualized. It’s not a pretty picture, and you can see how the interest from Bills has absolutely ballooned.
Figure: 5 Net Interest Expense
The Fed has come out with its dot plot that shows a calm glide path down. Well, we can take the debt maturity and push it forward at the projected rate of the Fed. Even given the current proposed 6 rate cuts, and getting back to 3.5% by early 2025, the trajectory for interest expense is not looking good.
Given current projections by the Fed, the Treasury will owe over $900B on interest by 2025. That is a debt-death spiral. The Fed had to pivot back in 2018 when interest expense neared $400B. Next year, the cost will be more than double that!
Figure: 6 Projected Net Interest Expense
There is a potential third option. It’s an election year. Maybe Yellen is doing everything and anything to keep the financial system running smoothly. She has decided that the Treasury market must remain 100% stable and wants to take no chances. Thus, she issues tons of short-term debt, costing the taxpayer an extra $30B this year, and decides it’s a problem to be fixed at a later date.
While this would be wildly irresponsible and corrupt, the real argument against possibility 3 is the same as possibility 1, the market should be able to ingest at least some medium-term debt. This means the only logical conclusion is that she knows rates are coming down hard and fast. How does she know? Well, she used to be the head of the Fed. There is no doubt, everyone in Washington can do the simple math above and recognize the Fed cannot take a glide path down. The only option is for rates to come down. Yellen just bet $2T on that outcome. She’s not gambling though; she is making an informed decision.
Data Updated: Monthly on fourth business day
Last Updated: Dec 2023