Opinion: With high US debt load, watch Treasurys investments

Don Davis

This year, the U.S. national debt exceeded $34 trillion for the first time in history. In addition, the federal budget deficit for fiscal 2023 reached $1.7 trillion.

Concerns over the federal government’s fiscal health primarily center on its debt load. Last year’s federal budget deficit amounted to 6% of all U.S. economic output, and the country’s debt must increase every time the government runs an annual deficit.

The national debt now exceeds total U.S. gross domestic product, producing a debt-to-GDP ratio of about 120%. The Congressional Budget Office estimates that without changes to existing laws, the U.S. debt-to-GDP ratio will reach 129% by 2033 and 192% by 2053. These rising debt levels could pressure the federal government’s ability to fund discretionary spending programs, which likely would filter down to create financial headwinds for businesses and consumers alike.  

Another consideration is the government’s soaring costs to service its debt as interest rates have risen over the past two years. In the fourth quarter of 2023, the U.S. paid 49% more in net interest payments that it did in the same period the prior year, according to a Fitch Ratings report. In addition, when interest rates increase, it creates a ripple effect on the rates charged to businesses, households and local governments, and acts as a brake on economic growth.

The CBO projects interest on the debt over the next decade will surpass $10 trillion and exceed the defense budget by 2027. As interest expenses absorb more of the federal budget, there are simply fewer dollars available for other budgetary priorities.

Eyes on the Fed
Still, the markets appear focused on when the Federal Reserve is likely to start cutting interest rates this year. However, economists believe it is equally important to understand how the Fed intends to manage its balance sheet, which is filled with U.S. Treasury securities the government issues to fund new debt and roll over existing debt obligations. If, when and how the Fed chooses to sell the Treasury securities it has purchased in recent years has important implications for the markets and investors.

The Fed is the single largest holder of that debt, and it has been stepping away from the market through a process known as quantitative tightening. The U.S. central bank currently allows about $95 billion in Treasury and mortgage-backed securities it owns to mature without being replaced each month. This lack of demand has compounded the impact of the Fed’s hikes to the overnight federal funds rate, resulting in interest rates across all Treasury maturities that are as high as we’ve seen in over 15 years.

Unique debt burden
Although a debt-to-GDP ratio above 100% represents an understandable level of fiscal concern, there are positive attributes working in America’s favor. The U.S. dollar’s status as the world’s reserve currency creates underpinning demand for Treasurys.

Our strong economy and abundant resources also bolster our ability to service debt. In addition, retiring baby boomers and an otherwise aging population probably will have a desire to own low-risk, long-term assets, providing another likely source of demand for Treasurys in the coming years.

This presents investment opportunities in the fixed income markets, especially in longer-maturity bonds. The prospect of generating steady returns for periods as long as 30 years may make sense for investors. Adding duration to a fixed income portfolio also could act as a counterbalance to the volatility inherent in equity returns.

Don Davis is a senior portfolio manager for Commerce Trust in Springfield. He can be reached at don.davis@commercebank.com.