Interest Rate Ruminations

Ticker goes bananas.

To put this in context you can look at the interest expense of The Federal Government. You will note that despite debt going up a lot in Fiscal 2009 the interest expense went down - a lot (about 15%.) But this year interest expense, if it tracks the five months thus far in the books, will rise from $383 billion to $434 billion, a 13% increase - almost erasing the "gains" from the zero interest-rate policy.

On September 30th 2009 the outstanding debt was $11.909 trillion dollars. That is an average interest coupon across the entire float of the public debt of 3.22%.

Now consider what happens if short rates go back to the 5% range - a historical reasonable point, and long rates go into the 7% range (a point that this chart's inverted head-and-shoulders, by the way, says is likely within the next two years):

[Chart here]

Assuming Treasury continues to try to shove toward the short end of the curve, a strategy that exposes it to extreme amounts of rollover risk, the average coupon would likely rise to about 5.5%.

This would drive interest expense to $780 billion by September 2011.

Note that if historical averages hold, Treasury would take in roughly $1.2 trillion in personal income taxes. Interest expense would rise to consume approximately 2/3rds of that amount.

The key phrase is 'assuming that Treasury continues to .....shove toward the short end...'

During the Clinton Administration, long rates were high, so Treasury stopped selling 30-year bonds and 'went short,' emphasizing T-Bills and T-Notes--short-term debt (out to 10 years or so.)

It's possible that in the future, long rates will be favorable compared to short, (and that TurboTimmy will figure that out), and Treasury will go back to issuing 30-year bonds.

Of course, Timmy will tip Goldman Sachs first. Somebody's gotta profit from that!