Will $1Trillion in interest payments force lower rates?

In Q4 2023, the interest on the federal debt surpassed 1 Trillion dollars [1] for the first time. That’s almost double the amount we paid in Q4 2019 ($565B), and is truly an unfathomable amount of money to be paying simply to cover the cost of maintaining our deficit (not to pay it down).

Given the federal government only collected a total of $4.44T in 2023[2], including $1.61T in social security and medicare taxes, it becomes clear why we are continuing to run a significant deficit.

The doubling of the interest payments over the past 4 years is a combination of an increase in the debt and an increase in interest rates. The government spending increased during the pandemic [3] from $5.31T in 2019 to $7.72T in 2020, and while it has decreased since that spike, at $6.13T in 2023 we are still well above what would normally be expected. Since the excess spending is added to our deficit, the amount of interest we pay would increase simply because of that. However, the fed also dramatically increased interest rates [4], moving the federal funds rate from under 0.1% to over 5.25% in under 2 years. That has had the effect of increasing the interest rate on the 10yr treasury from 1.75%-2.00% in Q4 2019 to over 4.25% in Q4 2023, which would more than double the interest payments on the new debt.

The increase in interest payments on the federal debt is one of the reasons people keep talking about the Fed having to lower interest rates – since lowering the rates will reduce the debt payment. This position is based on the assumption that we cannot afford to make these high interest payments for an extended period of time.

I am not convinced. While interest rates are high by recent standards, they are not high historically. And lowering them quickly would likely spur a new round of inflation and asset bubbles as loans become cheaper again.

The US is in a unique situation as the world’s reserve currency. Since all of the money we owe other nations is in US dollars, it is possible for us to get out of this situation by simply printing more money over time. As long as we keep the interest rates high enough that the velocity of money remains low, which dampens consumer inflation, printing more money allows us to pay off the debt. This will lead to some inflation as the money supply will increase and eventually work its way into the consumer market, but if that stays close to the Fed’s target 2% rate, this seems like the most likely path forward to me.

In addition to large debt payments, keeping rates high could cause problems for the banking system as the banks hold a lot of long-term assets and debt at lower, fixed, interest rates. While not a problem if the bonds are held until maturity, if the bonds are sold, they are worth less than originally paid if for. Forced selling of under-water bonds is a big part of what caused the failure of Silicon Valley Bank [5]. I believe that the safeguards that the Fed put in place after that failure – essentially becoming a buyer for bonds held by the banks at face value – can be used to offset this risk in the future.

Given the risk of inflation and asset bubbles if interest rates are lowered significantly, and the mitigations in place that allow the fed to keep the rates higher, I am not planning for any major change in interest rates. I do think it is likely that the Fed will make minor adjustments in the rate, but I am not expecting a decrease of more than 1% in the foreseeable future, unless there is a major economic event that forces the Fed to act more aggressively.

Of course, my crystal ball is not always the best, and many people I know are expecting significant decreases in interest rates over the next few years. I certainly wouldn’t object and would love to take advantage of lower rates if they come back. But it isn’t something I am counting on.

In the meantime, my underwriting assumes that the current interest rate environment will remain at current levels.

If you have any questions or comment about this post, please email them to me at blog@mbc-rei.com, I will reply to the questions that are straightforward and will turn the questions requiring more detailed answers into future blog posts.

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This article is my opinion only, it is not legal, tax, or financial advice. Always do your own research and due diligence. Always consult your lawyer for legal advice, CPA for tax advice, and financial advisor for financial advice.