Executive Summary
As described last week, rising Federal debt combined with higher interest rates, translates to 2024 U.S. interest expense consuming nearly 62% of U.S. income tax revenue. As shown in the first graph below, GDP growth is slowing. The brewing crisis results from the uncontrollable fiscal spending, driving growth at a slower pace (2nd graph). And thus, requiring more debt per dollar of output. However, persistently high inflation is delaying any interest rate cuts, and could result in another interest rate hike. Then U.S. interest expense on its ballooning debt could result in a U.S. debt downgrade. Why are our leaders not discussing this potential financial crisis?
Please continue to The Details for more of my analysis.
“The financial crisis happened because no-one could actually say out loud how bad things were.”
–Mark Ravenhill
The Details
In last week’s newsletter, I described how rapidly growing Federal debt and rising interest rates have catapulted Federal interest expense to the top of the budget categories. For instance, expected interest expense for 2024 could consume up to 62% of total income tax collections. This situation is pushing the U.S. towards a fiscal crisis, yet little is heard about it from politicians. In this missive, I will illustrate how the heavy debt load is impacting economic growth.
Last week, the Bureau of Economic Analysis (BEA) released the advance estimate of Quarter 1, 2024 real economic growth. The real GDP rate significantly disappointed analysts, as expectations were for much higher growth. The Q1 result, on an annualized basis, came in at 1.6%. As can be seen in the chart below, after the surge in growth resulting from unprecedented Covid19 stimulus programs, growth is beginning to fall.
The crisis that is brewing results from uncontrollable fiscal spending. Even in “good” times, the Federal deficit is growing. Notice in the graph below, the amount of debt undertaken (red line) to produce economic growth (blue line). This gap is widening and, when combined with rising interest rates, leads to interest expenses that could soon become unpayable. During calendar 2023, it took $3.75 of new debt to produce $1 of output. The concern should be obvious.
Some readers might be thinking that interest rates will fall soon, therefore, interest expense could become more bearable. At the end of last year, the Fed was predicting inflation returning to a trajectory that would lead to their 2% target, which would allow at least six interest rate cuts in 2024. Inflation has proven to be more resilient than expected, and now many analysts are wondering if the Fed might be forced to raise rates again, before ever lowering them.
The graph below shows that since bottoming at the end of last year, the CPI (Consumer Price Index) is now on the rise again. Hedgeye Risk Management expects inflation to continue on the uptrend. If correct, it is likely the Fed will not be able to lower rates this year. And depending upon the extent of the rise in inflation, they could be forced to raise rates. Of course, this is an election year, so anything is possible.
If the current CPI uptrend continues, the likelihood of rate cuts this year disappears. This refocuses the concern about an unstoppable increase in the Federal debt combined with rising interest rates. This combination could push interest expense up to almost three-fourths of income tax collections. And it should be noted that taxes received for Social Security and Medicare are already less than their related expenses.
This is leading to the biggest potential financial crisis of our lifetime, yet no one in charge seems to be concerned. If left unchecked, Federal debt will be downgraded further and a crisis will be unpreventable. I cannot understand why this is not one of the top priorities of our leaders.
The S&P 500 Index closed at 5,100, up 2.7% for the week. The yield on the 10-year Treasury Note rose to 4.67%. Oil prices increased to $84 per barrel, and the national average price of gasoline according to AAA fell to $3.66 per gallon.
© 2023. This material was prepared by Bob Cremerius, CPA/PFS, of Prudent Financial, and does not necessarily represent the views of other presenting parties, nor their affiliates. This information should not be construed as investment, tax or legal advice. Past performance is not indicative of future performance. An index is unmanaged and one cannot invest directly in an index. Actual results, performance or achievements may differ materially from those expressed or implied. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy.
Securities offered through First Heartland Capital, Inc., Member FINRA & SIPC. | Advisory Services offered through First Heartland Consultants, Inc. Prudent Financial is not affiliated with First Heartland Capital, Inc.