Interest Rates: Still Cheap, But Climbing

With the $1.9 trillion American Rescue Plan underway, press coverage continues to spotlight the enormous stockpile of national debt tapped to fund government expenditures, but there’s another component that is just as important—the interest rate on the debt being issued. Cut out some zeros in the amount our federal government is borrowing, and it’s no different than a cooperative taking out a new loan. Both the loan size and interest rate will impact the mix of debt on the system’s balance sheet and move interest expense on the income statement either up or down. You might call it the borrowing one-two punch, though most people just focus on the first blow—the size of the borrowing.

On the Bright Side …

The interest rate, folks, is the silver lining that U.S. Treasury Secretary Janet Yellen is hanging her mask on. Yellen has addressed Congress multiple times, repeatedly saying that the country can afford to borrow more with interest rates at historic lows. In fact, she often points out that despite holding much more debt, the cost to service those obligations is the same as it was in 2007. So, just like members have benefited from the low interest rate environment, so, too, has the federal government. In fact, the average life of the outstanding Treasury issuances has come down from 70 months to just 62 months to take advantage of the current situation.

Sunnier Days Are Coming

But the story doesn’t end there. The U.S. economy needs to get back to full employment as fast as it can by growing the economy. Then, with more federal taxes rolling in, the administration can start to pay down the outstanding debt without so much pain. This is the strategy being implemented now—growing the economy faster than the deficit-financed debt is being added. And, it’s working. The economy has shown resiliency and is reporting stronger economic numbers every month.

There is also concern about interest rates rising, leaving the Treasury to roll over or refinance remaining debt at future, more costly rates. Yes, interest rates are expected to be driven higher by the growing economy and rising inflation. How high will they go? Well, that is the million-dollar question.