Debt Dangers for 'Dummies': The USD 1 trillion Interest Wall!

The US will have to refinance almost half of its outstanding debt at MUCH higher yields

Austria is one of the few countries that has actively taken advantage of ultra-low bond yields. It has issued a series of (almost) 100-year and other long-maturity bonds. As a result, more than 16%, or one-sixth, of Austria's government debt has a maturity of 25 years or more.

How different it is for the US. Barely 6% of US government debt has a maturity of more than 25 years, and according to my Bloomberg screen, the US does not engage in maturities of more than 30 years. But, more importantly, in the coming three years, the US must refinance nearly half(!) of its outstanding debt. That makes the world's largest economy and bond market, by definition, vulnerable to (short-term) interest rates. And with Powell determined to keep interest rates high for as long as possible, this will become quite painful. Let me do a straightforward calculation exercise to illustrate this.

A massive spike!

To better understand the impact of rising interest rates, I compare the implied interest costs of total US government debt based on current rates with those of September 2021, just before the spike in yields commenced. These costs are an estimate. First, because the debt distribution and size are not the same in 2023 and 2021. Second, because actual interest expenses differ, for example, due to zero-coupon bonds, the US issued bonds below par without paying interest in return. Nevertheless, this calculation comes quite close to reality, as demonstrated below.

This chart shows the current yield curve compared to September 2021. The rise in interest rates has been extraordinary.

A seven-fold increase!

This is reflected in (annualized) interest payments. Consider the outstanding debt that needs to be refinanced this year. The first chart revealed that this accounts for a whopping 19% of total outstanding debt. Refinancing this debt alone will translate into USD 270 billion in interest payments based on current short-term yields. In 2021, refinancing this short-term national debt would have resulted in just USD 3 billion in annual interest payments. That's 90 times(!) as much.

Now, imagine that the US has to refinance its entire debt pile at current yields. The total interest payments would amount to USD 1.33 trillion, representing more than 5% of US GDP! In 2021, the total interest payments would have been USD 187 billion, implying a (theoretical) seven-fold increase.

A Ballooning Burden!

Obviously, the US will not have to refinance its entire debt all at once. But because nearly half of it will mature in the next three years, and Powell hinted that it could take years for yields to come down, the US will be 'locking in' a significant portion of those rising interest payments. While I don't think the Fed will succeed in keeping yields at the current levels for that long – because, you know, recession – a substantial increase in interest payments looms large on the horizon.

The chart above shows the OECD's (estimated) interest payments for the US. In 2024, these are expected to reach 4.4% of GDP, not too far off from the estimate above of more than 5%. Add to that the structural primary budget deficit of the US, as expected by the Congressional Budget Office (CBO), and you get this disturbing chart:

If you're still wondering where yields are heading in the long term, look no further.

And for Austria? Its interest payments chart looks much more sanguine.

For 2024, interest payments are expected to represent 1.23% of GDP. This is partly due to debt monetization by the ECB but also due to the proactive debt policy of the Austrian government.