The interest rate snowball is getting bigger and bigger! If the Federal Reserve raises interest rates by 75 basis points this year, US interest payments will increase by $50 billion annually.

The interest rate snowball is getting bigger and bigger! If the Federal Reserve raises interest rates by 75 basis points this year, US interest payments will increase by $50 billion annually.

The U.S. fiscal situation is facing a severe test from the dual pressures of interest rates and debt. With the Federal Reserve expected to raise interest rates again this year, coupled with the U.S. national debt surpassing $40 trillion for the first time, the spiraling increase in interest payments is becoming Washington's most unavoidable fiscal threat.

In her latest report, Bank of America's chief economist, Aditya Bhave, estimates that if the Federal Reserve raises interest rates by a cumulative 75 basis points this year, as the market expects, annual interest payments on short-term Treasury bills (T-Bills) alone will increase by approximately $50 billion, equivalent to about 15 basis points of GDP. Meanwhile, total interest payments in the U.S. over the past 12 months have already reached a record high of $1.4 trillion and are expected to surpass Social Security spending within the next two years to become the largest single item of federal government spending.

This trend has significantly heightened market concerns about the sustainability of US fiscal policy. Bank of America warns that there is a self-reinforcing feedback loop between interest payments and deficits—higher interest costs push up deficits and the size of Treasury bond issuance, which in turn raises term premiums and borrowing costs, further exacerbating the interest burden and creating a vicious cycle that is difficult to break.

The proportion of short-term debt has risen sharply, increasing its sensitivity to interest rate hikes.

The U.S. Treasury's reliance on short-term Treasury bills has risen to its highest level since 2010 (excluding the emergency financing phase during the COVID-19 pandemic). Currently, T-bills account for 23% of total outstanding U.S. debt, with outstanding T-bills amounting to nearly $7 trillion, the vast majority of which will mature within one year.

A direct consequence of this debt structure is that the federal government's borrowing costs are extremely sensitive to changes in short-term monetary policy. Bank of America points out that once the Federal Reserve raises interest rates, the interest payments on this portion of short-term debt will be reflected in the fiscal bill almost immediately, without waiting for the refinancing cycle of long-term bonds.

Bank of America expects the Federal Reserve to raise interest rates once this week, followed by two more hikes later this year, totaling 75 basis points. Based on this, it estimates that T-Bills' annual interest costs will increase by approximately $50 billion.

Refinancing pressures continue to accumulate, and long-term interest rate costs remain high.

In addition to the immediate impact of short-term debt, the refinancing pressure of long-term debt should not be ignored. Bank of America data shows that the average interest rate on outstanding market-based Treasury bonds is currently around 3.4%, far below the current market yield level.

Specifically, for coupon securities, the refinancing rate for debt maturing and being rolled over in the next few years will, on average, be about 1.4 percentage points higher than that of maturing bonds. This means that even if the Federal Reserve does not raise interest rates further, at the current interest rate level, US interest expenses will continue to rise as the debt maturity structure evolves.

This year, the US fiscal deficit is projected to exceed 6% of GDP again, with interest payments surpassing defense and healthcare spending to become one of the main drivers of the deficit expansion. Bank of America points out that the deteriorating trend in interest costs is particularly pronounced compared to relatively stable spending items such as Medicare, defense, and Social Security.

The feedback loop between debt and interest rates leads to the long-term accumulation of fiscal risks.

The Bank of America report emphasized a more fundamental risk: the feedback loop between interest rates and debt. The core of debt sustainability lies in the gap between borrowing costs and nominal GDP growth—when nominal growth exceeds borrowing costs, the debt/GDP ratio can stabilize over time; however, once this gap narrows, high debt levels become increasingly unsustainable.

Bank of America simulated three scenarios for the debt-to-GDP ratio: under low, medium, and high assumptions, a 1 percentage point increase in the debt-to-GDP ratio would push interest rates up by 1, 2, and 3 basis points, respectively. While the initial impact is limited, the debt trajectories under the three scenarios will diverge significantly over time—higher debt levels lead to higher borrowing costs, thereby accelerating debt accumulation.

Bank of America also points out that deficits driven by interest expenses differ fundamentally from those driven by tax cuts or government spending in their economic effects: the former provides far less support to economic activity than the latter, and may crowd out public and private investment by continuously raising long-term interest rates, and weaken the government's ability to provide fiscal support during economic downturns.

The pressure of government bond supply may be transmitted to the long term.

From a market perspective, changes in the deficit composition mean an increase in the supply of Treasury bonds, but this is not accompanied by a corresponding boost in economic growth. Bank of America believes this will put additional upward pressure on the supply of Treasury bonds, the term premium, and the long end of the yield curve.

Peter Tchir, a trader at Academy Securities, said that raising interest rates would not help the fiscal situation given that interest payments are already problematic relative to defense or discretionary spending. He stated, "It's hard to imagine President Trump being satisfied with this, even if rate hikes help suppress long-term yields, the stock market hasn't fully priced in that effect."

Bank of America's conclusion is straightforward: there are no winners for the United States in terms of an additional $50 billion in interest costs—except for creditors holding short-term U.S. debt.

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