The U.S. government’s interest bill is skyrocketing

The U.S. government’s fiscal outlook has become markedly worse in the last couple of months — not because of anything happening on Capitol Hill, but because of shifts in global bond markets.

Why it matters: An upward shift in long-term interest rates is putting the government on track to spend much more on interest payments in the coming years than was anticipated just a few months ago.

• If current rates stay high and fiscal policy matches current forecasts, the cost of servicing those debts will surpass defense spending in 2025 and top Medicare spending in 2026.
• In the current fiscal year, interest spending is on track to surpass $800 billion, more than double 2021’s $352 billion figure. In 2026, the government’s net interest expense would reach 3.3% of GDP, the highest on record.
• Those numbers are from the Committee for a Responsible Federal Budget, on the assumption that rates remain 1 percentage point higher than in the Congressional Budget Office’s forecasts, based on the CBO’s rules of thumb.

By the numbers: In July, the CBO fiscal projections assumed that the 10-year U.S. treasury bond would yield 3.8%, which was about where the securities were trading at the time.

• Not anymore. Since then, the 10-year yield set new modern highs, surpassing 4.8% on Oct. 6 (it was 4.71% on Monday morning).

How it works: Higher rates increase the burden of old debt — but not all at once. As the longer-term Treasury securities that were issued during the low-rate era (roughly 2008 to 2021) gradually mature, rolling over that debt will be more expensive.

• Some $207 billion in Treasury notes matured this month alone, originally issued in 2021, 2020, 2018, 2016 and 2013. Their weighted average interest rate was 1.2%, according to Axios calculations.
• They will be replaced by newly issued debt in the ballpark of 5%. The same thing is on track to happen every month for years to come.

Yes, but: Markets can shift abruptly, as the last few months show, so it’s possible rates could return to something closer to their pre-pandemic norms in the years ahead, easing the pressure.

What they’re saying: “Interest rates are higher than anyone anticipated, and if they remain high, interest costs will explode,” Marc Goldwein, senior policy director for CRFB, tells Axios.

• “With interest rates well above expected economic growth rates, we also risk a debt spiral — especially if further borrowing pushes rates up more,” he added.

One open question is how the onset of higher interest costs — and the squeeze that will put on everything else the government does — may affect the political landscape.

Between the lines: For the last 15 years, low rates made for something of a fiscal policy free lunch for elected officials. Debt service costs were persistently low as a share of the economy, so there was little apparent cost.

• Even as deficits soared — with the recession and Obama stimulus in 2009, Trump tax cuts in 2018, and pandemic rescue spending in 2020 and 2021 — there were, at first glance, few tradeoffs.
• In 2020 and 2021, for example, even as nearly $5 trillion in pandemic spending went out the door, the government spent only 1.6% of GDP on interest.
• Compare that to 2000, when the economy was booming and the budget was in surplus — and debt service costs were 2.2% of GDP.

The question now is whether high-interest expenses change the politics and focus the attention of fiscal policymakers. That’s what happened the last time interest costs occupied as large a share of the economy as they are now poised to.

Flashback: Interest expenses reached high levels relative to the economy in the late 1980s, peaking in 1991 at 3.2% of GDP. This environment set the stage for deficit reduction by Presidents George H.W. Bush and Bill Clinton.

The bottom line: The political conversation in Washington has not yet adjusted to a world in which high-interest costs are a binding factor for both Republicans who want to cut taxes and Democrats with ambitious spending plans — but the numbers may force that to change.