2024 Election Season: Will The Fed Be Able To Ignore The Rising US Debt and Interest cost?
Heading into a potentially pivotal US presidential election in November, investors will likely turn their attention to the intersection of fiscal and monetary policy.
- Interest costs have become one of the largest categories of government spending as the Fed has raised rates.
- In our view, rising debt and interest costs will become hard for the Fed to ignore -- it is one of the many factors that are increasingly important to watch outside of traditional employment and inflation metrics.
In May 2024, Federal Reserve Chair Jerome Powell punctuated a long-standing claim: The Fed stays out of politics.
“…this is my fourth election, fourth presidential election here. Read all the transcripts, and see if anybody mentions, in any way, the pending election. It just isn’t part of our thinking. It’s not what we’re hired to do. If we start down that road, again, I don’t know how you stop.”
– Fed Chair Jay Powell at the May 1, 2024 press conference
While that may be the Fed's intent, our research shows that the enormity of the US debt could impact monetary policy and elections, especially as interest expenses rise to record levels.
Net interest outlays will be the biggest driver of deficits.
In 2023, interest expense surpassed most other categories of spending, including Medicaid, Spending on Children, Veterans' Programs, and Income Security Programs.
While most policymakers are reluctant to discuss this burden, former policymakers, even those who are less concerned about the overall debt, have expressed concern about the interest burden.
"Interest rates are a really critical part of all of this. And this is a lot of why my mind keeps changing about the debt, because I’m much more worried about debt service."
- Jason Furman, former Chair of the Council of Economic Advisors
The debt service burden is not set in stone, though. In fact, it is the most widely missed projection of all the components in the nonpartisan Congressional Budget Office (CBO) forecasts.
"Over the 1993–2021 period, the agency substantially overestimated interest rates. For example, in March 2011, CBO projected that interest rates on 10-year Treasury notes would average 4.8 percent over the 2011–2021 period...."
- CBO, noting their forecasts for 10-year rates proved too high by nearly 270 basis points, An Evaluation of CBO’s Projections of Outlays From 1984 to 2021
For over a decade, interest rates proved lower than the CBO's projections. But in Fiscal Year 2023, interest rates and, in turn, interest expense exceeded the CBO's projections for the first time since the 2008 financial crisis.
The Fed may have to focus on more just the "dual mandate" of stable prices and maximum employment
Today, given the size of interest costs, the Fed will have a hard time ignoring that their actions could have a material impact on overall debt levels -- they run the risk that the cost of servicing the debt ultimately causes them to lose control of long-term interest rates.
"The Federal Open Market Committee (FOMC) is firmly committed to fulfilling its statutory mandate from the Congress of promoting maximum employment, stable prices, and moderate long-term interest rates. "
Amid a heated political environment, markets may focus more on the "moderate long-term interest rates" part of the mandate. The pressure on debt levels from interest expense could bring fear of more than moderate upward pressure on long-term interest rates. This is one of the many factors that are increasingly important to watch outside of traditional employment and inflation metrics. See our previous piece on the potential impact of economic volatility on Fed policy.