'Pivot' on fiscal policy will occupy investors for foreseeable future
The U.S. Federal government has a serious, serious math problem. A math problem so big it is quickly becoming the collective problem of all of us who live here and use U.S. dollars to conduct our business.
The math involves the bonds the Federal government uses to finance its operations when it spends more than it takes from American businesses and residents in taxes and fees. This amount is called the deficit, and the bonds issued to finance these deficits added together over time are referred to as the national debt. It's important to understand the distinction between the two terms.
We are used to hearing the political theatre over the deficit. One political side cries about it and keeps spending, the other ignores it and keeps spending. Underneath this theatre, however, is an actual portfolio of bonds which need to be serviced, "paid off" and managed. These bonds, US Treasury securities, underpin the world financial system and are considered the most secure financial instruments on the planet. Managing these bonds properly has arguably become the most important function of the government. This management task belongs to the United States Treasury Department, aided by the Federal Reserve Bank, which controls the money supply required to sustain the process.
According to data on the St. Louis Branch of the Federal Reserve Bank website, about $9 trillion of US Treasury securities will mature during 2025. When these securities mature the bond holders are entitled to a return of their principal, as well as accrued interest.
Of course, the government never actually "pays off" any debt -- instead as these bonds mature, they are "rolled" forward in a refinancing operation involving issuing new bonds to pay off the maturing securities. These refinancing operations happen every month, most often behind the headlines, as this routine part of public finance mostly involves large institutional investors and doesn't typically get a lot of attention from media or the American public.
I've seen people struggling with too much credit card debt play a similar game using the "zero percent" roll, as they continually open new credit cards offering special introductory rates and then roll their existing balances from card to card attempting to avoid paying crazy high credit card interest. While this may look clever, it's not a great game and in my experience often eventually goes bad. While government finances work differently, similar problems can also manifest with public finances, some of which is occurring in 2025.
The serious math problem charging toward the government also involves interest rates. Interest rates in the United States were extremely low, around 2% or less, from late 2008 to late 2022. During much of this period, the lowest interest rates were payable on shorter term notes and bonds, and much of the Federal debt was funded with short term Treasury securities as well.
During the decade while rates were very low, many analysts publicly encouraged the government to use longer term bonds to finance the national debt, locking in these low rates for as long as feasible. But the government doesn't always behave in ways that are easy to understand, and much of the Federal bond portfolio remains financed using short term bonds, which is where the challenge comes.
After inflation flared resulting from COVID era policies, followed by obscene deficit levels in 2021 to 2024, the Federal Reserve raised short term interest rates in an effort to cool the economy and slow price increases. Now, after the most aggressive rate increase cycle in decades, short term interest rates are around 4.5%.
So, let's say for discussion purposes much of the bonds maturing in 2025 carry interest rates below 2%, and will be refinanced at rates around 4.5%. If the government needs to refinance $9 trillion in bonds and issue another $2 trillion just to fund its deficit in 2025, simple math says this could amount to increased interest expenses of around $350 billion in fiscal year 2025/2026 alone. Yikes.
The Treasury Department under Secretary Bessent is clearly aware of this issue and recently stated publicly that reducing longer term interest rates is a key objective of the Trump administration. But unlike short term interest rates which are set by the Federal Reserve, long term rates are set in the bond market and are subject to complex market forces involving investor expectations for growth, inflation and future borrowing. Just how the Treasury can influence longer term rates remains uncertain.
The answer now seems to be some combination of DOGE, tariffs, deregulation, tax relief and what is being called the "pivot" from an economy heavily impacted by government spending and government hiring, to an economy supported by a growing private sector. The policies and implementation of this pivot are likely to dominate the attention of investors for the foreseeable future and we will continue to explore.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Stock investing includes risks, including fluctuating prices and loss of principal. No investment strategy can guarantee a profit or preserve against loss. Past performance is not a guarantee of future results. Marc Ruiz is a wealth advisor and partner with Oak Partners and registered representative of LPL Financial. Contact Marc at marc.ruiz@oakpartners.com. Securities offered through LPL Financial, member FINRA/SIPC.
