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WAKE-UP CALL

I am a bit of a gym rat…actually, I am a complete gym rat. Not only do I want to keep in shape, but I do some of my best thinking when I am working out. This morning, while on the elliptical trainer, I was thinking about the impact of higher interest rates on the national debt. When I arrived to the office, I searched the internet and found that as of February 2024, the blended yield on the national debt is 3.2%. Well, that is not so bad. My office is dominated by three large screens with a variety of Bloomberg analyses to help me keep on top of our portfolios and the market. So, as I look at the current yields on Treasury Notes and Bonds, I see the 2-year Treasury yielding 4.96% and the 30-year Treasury Note yielding 4.79%, and the 3-month Treasury Bills are yielding 5.36%[1]. Simply, taking a straight average of 3-month Bills, and 2, 3, 5, 7, 10, and 30-year securities, one sees a blended yield of 4.86%[1].

Let’s pretend for a moment that we snapped our fingers and the blended interest rate was now 4.86%. Based on total national debt of $34.4 trillion, the debt service would grow from the current $1.10 trillion to $1.67 trillion. Even in Washington, $670 billion is a lot of money. While we are having fun with numbers, consider that the current budget calls for $7.3 trillion in spending. The potential negative impact on the budget due to the total debt cost increase from the current 3.2% blended yield to the simple average current yield of 4.86% blended debt cost, would represent almost 9.5% of the current budget. I fully appreciate that the national debt is not going to roll over in an instant, but our penchant for utilizing shorter term funding would have an even greater negative impact because Treasury Bills are yielding 5.36%; funding with these short-term instruments will be even more expensive.

Some of the numbers and calculations I cited are meant for shock value. The challenge that we have is that the rising cost of debt will need to be met by one of two things, and most likely it will be a combination of the two. We will either need to materially cut back on spending or we will need to increase taxes. Both will have a negative impact on the economy because tax increases send money to Washington rather than being invested or consumed, and cutbacks in government spending also harm aggregate economic activity.

In life, time is often the most valuable commodity because we cannot control it. When confronted with the potential for a negative outcome, time is a tremendous asset giving you the space to consider viable options and selecting a path forward. Decisions that are foisted upon us often end with lest than optimal outcomes. I hope for the former and I fear the latter. The reality is that we have allowed debt to dramatically increase because the cost of money was so cheap. Given the changing tide, decisions need to be made in Washington, or some less than pleasant choices may be the only ones left on the table.

[1] Source: Bloomberg as of 9:31 am EST, April 16, 2024

This commentary has been prepared by Knights of Columbus Asset Advisors (“KoCAA”) for informational purposes. Nothing contained herein should be construed as (i) an offer to sell or solicitation of an offer to buy any security or (ii) a recommendation as to the advisability of investing in, purchasing or selling any security. Any opinions and information expressed herein reflect our judgment and are subject to change without notice. Certain of the statements contained herein are statements of future expectations and other forward-looking statements that are based on management’s current views and assumptions and involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied in such statements. Actual results, performance or events may differ materially from those in such statements due to, without limitation, (1) general economic conditions, (2) performance of financial markets, (3) interest rate levels, (4) increasing levels of loan defaults, (5) changes in laws and regulations, and (6) changes in the policies of governments and/or regulatory authorities.

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