The acceleration in the national debt … skyrocketing interest payments … another … wave of new treasuries … why some billionaire traders believe yields will drop – for the wrong reason
Your government is robbing you, making it harder to achieve financial independence.
You already know this. But yesterday, a headline that most Americans missed signaled Uncle Sam reaching even deeper into your pocket.
To contextualize what we learned, let’s back up momentarily.
***Our politicians cannot stop spending
Our government’s official debt is approaching $34 trillion.
To help you understand the enormity of this amount, imagine you had unlimited $100 bills.
$1 million of these $100 bills would fit in a briefcase… $1 billion of these $100 bills would fit on 10 standard shipping pallets… and $1 trillion in $100 bills would cover a football field to a depth of 7 feet.
To house our government’s debt, we would need 34 of these football fields.
More alarming is the speed at which our government is filling these football fields.
As I just noted, today’s debt is nearly $34 trillion. Well, in June, it was just $31.5 trillion… in early 2020, before the pandemic, it was only $23.2 trillion.
Below is the chart we’ve provided before in the Digest. It dates to the 1970s, showing how our debt was growing at a linear pace until the 2010s, when it began to go exponential.
But even this gargantuan “official” $34 trillion number is misleading. That figure doesn’t include unfunded liabilities, such as Social Security, Medicaid, pensions, and various social safety-net programs, among other things.
Our government’s total debt, including unfunded liabilities is $211 trillion. And the last time I wrote about this – not even one-and-a-half months ago, on September 22nd – this unfunded liability level was just $193 trillion. So, in less than two months, this figure has jumped 9.3%.
That Is terrifying.
***The size of the interest payments on this eyewatering debt is becoming a huge problem
As the Federal Reserve has engaged in one of the most aggressive rate hikes campaigns in history, it has exploded the size of our government’s debt service payments.
In the same way that most Americans can’t afford an 8% mortgage rate today thanks to the Fed, the government is having an increasingly difficult time affording the run-up in its debt service cost, also thanks to the Fed.
The chart below dates to 1947, showing our government’s interest payments. There is no period in which debt service exploded so much, over such a short amount of time.
The more our government must spend on these ballooning interest payments, the less money it has left over in the budget to fund all the programs it has promised you and me.
To get a sense for how bad thing are, let’s go to the Peter G. Peterson Foundation (a self-described “nonpartisan organization dedicated to increasing awareness and accelerating action on America’s long-term fiscal challenges”):
The federal government already spends more on interest than on budget areas such as veterans’ benefits, transportation, and education.
In fiscal year 2024, interest payments will surpass the combined amount that the federal government spends on major healthcare programs other than Medicare, which is comprised of Medicaid, the Children’s Health Insurance Program (CHIP), and premium tax credits and related spending.
In fiscal year 2028, the federal government will spend more on interest than on defense.
***The government desperately needs more revenues to fix this problem
So, what will it do?
If you answered “tax more,” you’re right but that’s not the whole story. After all, if we divided our government’s debt and unfunded liabilities equally amongst all U.S. citizens, we’d each owe $627,888.
Clearly, this is an impossible debt for Americans to absorb, but even more so when you factor in how data from the Tax Foundation show that the top 50% of all taxpayers pay 97.7% of all federal individual income taxes, while the bottom 50% pay just 2.3%.
Now, yes, higher taxes will be coming for your wallet at some point. But if the government raised them too much, too quickly, the taxpayer backlash would be too severe.
Instead, the government will rob us a different way…
And this brings us to yesterday’s headline from CNBC:
This is something we warned about months ago.
Not enough people realize this just happened, what this means, and what it signals is on the way.
***How the government will rob us… what it means for the dollar… and what it means for your portfolio
The government is desperate for more money – and fast. So, what is it doing?
Issuing more debt through Treasury bonds.
From CNBC yesterday:
The Treasury Department announced plans Wednesday to accelerate the size of its auctions as it looks to handle its heavy debt load and with financing costs rising…
Most immediately, Treasury will auction $112 billion in debt next week to refund $102.2 billion of notes set to mature Nov. 15, raising more than $9 billion in extra funds…
The auction changes are important to investors because they could provide a window into where yields are heading. Markets have been concerned about whether there will be enough demand to meet Treasury’s needs, which would send yields up even further and possibly cause financial distress.
Keep in mind, what happened yesterday is just a continuation of what began this summer, resulting in a downgrade of U.S. credit.
Let’s go to Bloomberg from August:
The US Treasury boosted the size of its quarterly bond sales for the first time in 2 1/2 years to help finance a surge in budget deficits so alarming it prompted Fitch Ratings to cut the government’s AAA credit rating a day earlier…
The bump in issuance showcases the rising borrowing needs that contributed to Tuesday’s decision by Fitch Ratings to lower the sovereign US credit rating by one level, to AA+.
Fitch said it expects US finances to deteriorate over the next three years. That’s from an already enlarged position — the Treasury is penciling in some $1 trillion worth of issuance in all this quarter.
***Now, astute readers might be scratching their heads
Perhaps they read this snippet from Bloomberg yesterday:
Ten-year US rates dropped 18 basis points to 4.75%, with the move initially triggered by the Treasury’s plans to slow the pace of increase in its long-term debt sales.
“Slow the pace”? Wait. Didn’t the CNBC article just reference “accelerate the size of its auctions”?
Yes. Let’s clarify what’s happening.
Only two bond issuances are slowing – the 10-year and the 30-year. And the sigh of relief in the bond market is only because the issuance is slightly less than had previously been anticipated. Let me rephrase: It’s “barely” less – specifically, $112 billion of longer-term securities instead of the expected $114 billion.
Pop the champagne!
Meanwhile, what about the entire range of bonds?
Well, the Treasury increased planned issuance of 2-year, 3-year, 5-year, and 7-year securities by the same amount as in August. And there is no change in planned sales of 20-year bonds.
However, the bond market is such a sea of carnage today that even this slight “good news” is enough to push the 10-year Treasury yield lower.
Now, what is more genuinely encouraging is that the Treasury said it expects only a single additional step up in quarterly issuance of longer-term debt. But with the Fed committed to “higher for longer” rates, which means more tax dollars going toward federal debt service – not to mention the funding of two global wars today – we’ll believe it when we see it.
***Don’t miss what this bigger-picture ramp-up in bond issuances means for your stock portfolio
The government’s bottomless pit of spending creates a critical need for more money…
To generate more money, it’s issuing a massive volume of new bonds…
When a marketplace is flooded with more of something, Econ 101 tells us that the price of that thing drops…
Given the inverse relationship between bond prices and yields, when a government bond price drops, its yield climbs…
And when government bond yields climb – specifically, the 10-year Treasury yield – it means bad news for stock prices and the average investor portfolio.
As we’ve detailed here in the Digest, after four decades of falling, we’re now seeing a reversal in the direction of the 10-year Treasury yield.
With the government’s bottomless pit of spending now requiring an accelerated issuance of bonds, this suggests upward pressure on bond yields looking forward.
Sure, we’ll see bond rallies that lead to materially lower yields for a while – perhaps we’re seeing the beginning of one such rally today with the 10-year yield down to 4.66% as I write. But look above at the long-term upward trend in yields that’s begun and now has this “more bond issuance” tailwind.
Are you ready for a market environment that is categorically different than the one we’ve enjoyed for four decades?
***How bond yields could drop in a significant, sustained way despite this new bond issuance
For bond yields to stop climbing, we would need investors to clamor back into bonds (buying bonds pushes their prices higher, which sends yields lower).
So, when do investors clamor back into bonds?
Well, most times, it’s when they feel scared about the economy and investment markets and want the safety of bonds.
On this note, here’s Bloomberg from two days ago:
Billionaire investor Stan Druckenmiller said he’s bought “massive” bullish positions in two-year notes, as he’s become more worried about the economy.
In recent weeks, “I started to get really nervous,” Druckenmiller, founder of Duquesne Family Office, said in an interview with hedge fund manager Paul Tudor Jones at a conference last week. “So I bought massive leveraged positions” in the short-term notes, he said.
Druckenmiller has joined a number of prominent investors, including Bill Ackman and Bill Gross, in sounding the alarm about the economy lately….
Druckenmiller said he’s keeping bearish wagers on longer-term bonds because he’s concerned about swelling government-debt issuance.
(If you want to follow Druckenmiller into this trade, check out iShares 1-3 Year Treasury Bond ETF, SHY.)
So, on one hand, we have Druckenmiller betting on a bull market in short-term bonds due to growing risk of an economic meltdown. On the other hand, we have Druckenmiller’s bet against long-term bonds thanks to our government’s endless need for revenues. Not a great combo.
Are there any other billionaires betting on economic pain resulting in a bond bull market?
Yep – DoubleLine Capital CEO and “bond king” Jeffrey Gundlach.
From Gundlach yesterday:
I do think rates are going to fall as we move into a recession in the first part of next year…
I really believe that layoffs are coming. We’ve seen hiring freezes, and now we’re starting to see layoff announcements … they’re out there [for] financial firms and technology firms, and I believe that’s going to spread.
Yes, these guys have been wrong before and could be wrong again – we hope they are. But they’ve been right enough times to generate billions of dollars in the investment markets, so it’s worth paying attention to their forecasts.
***So, what do we do?
It’s the same prescription we’ve suggested for months now…
First, learn how to trade. Be ready to take advantage of shorter-term opportunistic market set-ups.
Second, be careful which stocks you trust for your buy-and-hold portfolio. You need high-quality companies that can grow their earnings despite a high-rate, high-yield environment. Even better if they pay healthy dividends.
Third, buy hard assets – real estate, farmland, commodities. The prices of such assets have a better ability to float on top of rising inflation. Plus, if those assets are income producing, even better (for example, rental real estate).
Stepping back, in recent Digests, we’ve argued that this oversold market is due for a bounce. It looks like that’s what we’re getting today, so let’s enjoy it and trade it higher.
But don’t ignore how macro forces are aligning today, and what that means for how Uncle Sam will be coming for your money.
Have a good evening,
Jeff Remsburg
