Treasury Scrambles to Lock in Rates as Borrowing Cost Soars
The Treasury increased the total debt by $125B in May after a brief drop in April. This brings the total debt increase so far in 2022 to $880B. More importantly, though, the cost to service the debt is exploding. Total annualized interest has increased by $40B or 13.5% since the start of the year!
With the Fed continuing to push interest rates up, this problem is just getting started. The Treasury recognizes this and is taking action. As can be seen below, this is the third month in a row where the Treasury is letting short-term Bills roll off and replacing them with longer-term debt.
Note: Non-Marketable consists almost entirely of debt the government owes to itself (e.g., debt owed to Social Security or public retirement)
Figure: 1 Month Over Month change in Debt
In January and February, shortly after the debt ceiling was lifted, the Treasury binged, adding $675B in debt within two months. To help the market absorb so much debt, it issued $283B in short-term Bills. Over the last three months, it has completely undone that move and has now let the total Bill balance shrink by $97B.
Figure: 2 Year Over Year change in Debt
This is a critical move by the Treasury as it attempts to stay solvent in the face of higher rates. After all, Janet Yellen is well aware of the importance of low-interest rates on keeping the debt manageable.
The short-term part of the debt is very exposed to short-term moves. The chart below shows that interest on Bills (12% of total balance) has grown by $18B since January. Interest on Notes (44% of total balance) has increased by $15B with interest on Bonds (12.2% of total balance) increasing by $6B.
Despite making up only 12% of the total debt balance, Bills represent the largest contributor to the increase in debt cost this year. With the Fed ready to raise rates another 100bps by August, the interest on Bills will rise at least another $36B by year-end!
Figure: 3 Total Debt Outstanding
The chart above shows interest as a % of total debt ($30T). The chart below shows the weighted average on just Marketable debt ($23T held by the public, $5.7T of which is held by the Fed).
The latest move by the Fed to extend the maturity of the debt has increased average maturity from 6.05 years to 6.16 years in a single month. This is represented by the spike in the blue line on the far right of the graph. The Treasury is moving as quickly as it can to reduce exposure to short-term rates.
Figure: 4 Weighted Averages
The Treasury is also using its cash balance to help reduce the amount of new debt being issued. After replenishing the cash balance in the wake of the debt ceiling saga, the Treasury has already used $200B in cash, bringing the balance from $964B on May 5th to $757B on June 3.
Perhaps this is the primary reason why Powell dragged his feed on raising rates. He couldn’t do it during the debt ceiling debate and then gave his pal Yellen two months to issue as much debt as possible before raising rates.
With both Powell and Yellen assuming this is a temporary rise in interest rates, they probably think they are in good shape to withstand the “brief” surge. The problem will manifest when the move up in interest rates proves to be anything but transitory.
Figure: 5 Treasury Cash Balance
Despite all these moves by the Treasury, it cannot avoid the inevitable rollover of debt at higher rates. There is simply too much debt. The chart below shows that it will roll over $3T in debt over the next three months alone.
The dark green bars show that rollover is down from its recent highs during Covid, but still above pre-Covid levels.
Figure: 6 Monthly Rollover
Note “Net Change in Debt” is the difference between Debt Issued and Debt Matured. This means when positive it is part of Debt Issued and when negative it represents Debt Matured
T-Bills (< 1 year)
Much of this will be in Bills, but the Treasury needs to be careful as the Bid to Cover ratio has fallen quite quickly over the last few months indicating less market demand for short-term debt.
Figure: 7 T-Bill Bid to Cover
This is concerning given how much short-term debt the Treasury is still rolling over each month. Of the $3T rolling over in total debt, $2.4T is in short-term Bills as shown below.
Figure: 8 Short Term Rollover
Treasury Notes (1-10 years)
The Treasury has also seen a large drop in the bid-to-cover for 10-year debt as shown below. It now sits at 2.4 which is the lowest level since August 2019. 2-year debt is still showing relatively healthy demand at 2.61 bid-to-cover. This is most likely due to the narrow spread between the two instruments. Investors only get an extra 28bps for 8 more years of inflation risk.
Figure: 9 2 year and 10 year bid to cover
While Notes have been the preferred method of debt financing, it does not buy the Treasury that much time. As shown below, nearly $6.15T will need to be rolled over by the end of 2024. This is exactly why the Fed and Treasury are hoping for a short inflation fight. A longer and harder fight would be devastating for the Treasury.
Figure: 10 Treasury Note Rollover
The chart below shows the trajectory of interest rates since 2000. The Treasury has benefited greatly from a consistent reduction in rates over the last 20 years. The tide has clearly turned as interest rates have exploded upwards unlike anything seen in recent history. The current move has happened faster than in 2006 and 2017. This is why interest payments are moving up so quickly, not to mention the enormous debt balance.
Figure: 11 Interest Rates
While total debt has now exceeded $30T, not all of it poses a risk to the Treasury. There is $7T+ of Non-Marketable securities which are debt instruments that cannot be resold. The vast majority of Non-Marketable is money the government owes to itself. For example, Social Security holds over $2.8T in US Non-Marketable debt. This debt poses zero risk because any interest paid is the government paying itself. The risk will be when Social Security needs to start selling that debt.
The remaining $23T is broken down into Bills (<1 year), Notes (1-10 years), Bonds (10+ years), and Other (e.g., TIPS). The Fed owns $5.7T, which also poses zero risk because the Fed remits all interest payments back to the Treasury. Unfortunately, that benefit has reached its peak (for now) and will even reverse as the Fed embarks on QT.
Figure: 12 Total Debt Outstanding
The chart below shows how the reprieve offered by non-marketable securities has been fully used up. Pre-financial crisis, non-marketable debt was more than 50% of the total. That number has fallen below 24%.
Figure: 13 Total Debt Outstanding
Historical Debt Issuance Analysis
As shown above, recent years have seen a lot of changes to the structure of the debt. Even though the Treasury has extended the maturity of the debt, it no longer benefits from the free debt in Non-Marketable securities. Furthermore, the debt is so large that even though short-term debt has shrunk as a % of total, it is still a massive aggregate number ($3.67T).
Figure: 14 Debt Details over 20 years
It can take time to digest all the data above. Below are some main takeaways:
- In a single year, Bills have fallen from 15.5% of the total to 12%
- Bonds now make up 12.2% of the total debt, the highest value based on the data available
- Notes make up 44.3% of the total debt, nearly double the amount 20 years ago
- Average maturity has increased from 2.85 years to 3.51 years
- Average interest rates on notes are now at 1.4%
- This is down slightly from a year ago (1.51%) but up since 6 months ago (1.35%)
- Annual interest on Bills has increased from $2.4B 6 months ago to $20.3B today
- This is a massive move in 6 months and is just getting started
What it means for Gold and Silver
Buckle up! The Fed is talking tough but they are trying to defy simple math. If the Fed gets aggressive with interest rates, the Treasury will see debt interest explode. Even with the modest increase so far, the annualized interest is up $40B and it’s just starting. With the Fed gone as the biggest buyer in the market, who will absorb this new debt? Interest rates will get pushed up. This is why rates are exploding higher. Is this the beginning of the debt spiral? The Treasury could be spending $500B just on debt service in short order!
The Treasury has done all it can to extend the maturity and obtain free loans from Non-Marketable debt. Unfortunately, time has run out. Their attempt to extend the maturity of the debt is valiant but futile. The debt has not been a problem for years due to low-interest rates, QE, and non-Marketable debt. All those tricks have been played, this is where the math takes over. Either the Fed rescues the Treasury by starting QE back up or the Treasury enters a debt spiral. This will not play out over several years… this is something happening right now and will dramatically change the outlook of the budget deficit within 18 months.
How will the Fed and Treasury respond to the new landscape? Will Powell let his friend Yellen drown in debt or will he rescue her? He did everything he could to give her runway to extend maturities and increase the cash balance, but that will only go so far. He may be talking tough with QT, but his next move will be a direct rescue as he starts monetizing the debt again (QE). Ensure yourself accordingly with physical precious metals.
Data Updated: Monthly on fourth business day
Last Updated: May 2022