June 21, 2024
By Steve Blumenthal
“All of the following factors appear to be inflationary: ongoing fiscal spending, remilitarization of the world, restructuring of global trade, capital needs of the green economy and possibly higher energy costs due to the lack of needed investment.”
– Jamie Dimon, CEO, JPMorgan Chase
One of the really good things about Dallas, Texas, is how much everyone who lives there loves living there—it’s a warm and friendly place. I was there for two days for a due diligence visit and an excellent dinner with clients and friends. With laptops and high-speed connectivity, we can all work from anywhere. Surprisingly, the Wi-Fi on Delta and American was seamless, and I got the latest news from the Congressional Budget Office (CBO) while traveling. The CBO released an updated 10-year budget forecast on Tuesday, and the news was not surprising: the U.S. government’s increase in spending continues. Sadly, the problem is not just persisting; it’s worsening.
According to the CBO, this year’s budget deficit is projected to be around $2 trillion. This figure is $400 billion higher than the CBO’s February forecast and $300 billion more than last year’s deficit. Such a high deficit is unprecedented, especially in a growing economy with relatively stable defense spending. This year’s deficit will constitute 7% of the GDP, a figure that surpasses deficits seen in some past recessions. And, as you’ll see next, the forces at play due to maturing debt and higher interest rates will keep that number going up.
Cut Medicare, Social Security, and defense spending? That isn’t going to happen—no current political will.
Looking ahead, the CBO predicts that deficits will remain near this level for years to come. Over the next decade, the total deficit is expected to reach $21.9 trillion, up from the $19.8 trillion estimated in February, with new debt issued to pay the costs. The CBO estimates the public debt will increase to 122.4% of GDP by 2034, up from 97.3% last year.
Interestingly, the CBO’s revenue projections have not changed much (think tax receipts). This year’s revenue is expected to be 17.2% of GDP, aligning closely with the 50-year pre-pandemic average. However, federal spending projections have significantly increased. The CBO anticipates spending to reach 24.2% of GDP this year and an average of 24% over the next decade. These numbers are striking. This is the coming crisis key analysts have predicted for some time—Ray Dalio’s End of the Debt Super-Cycle, and John Mauldin’s Great Reset (of debt and entitlements). We are kicking the can road to the cliff’s edge.
A Debt Trap
A record $9.3 trillion of Treasury debt is due to roll over this year. The total current outstanding debt is $34.8 trillion (small red arrow in the following chart). It is simple math to see that the Treasury debt’s interest expense will increase. According to Statista, “As of May 2024, the United States government has a monthly interest rate of 3.27 percent on its debt, continuing an upward trend in interest rates that began at the beginning of 2022.” (Statista has a really cool chart showing this, which you can find here.)
According to research by the Peter G. Peterson Foundation, “In 2023, the federal government spent $658 billion on net interest costs on the national debt. That total, which grew by 38 percent from $476 billion in 2022, was the largest amount ever spent on interest in the budget and totaled 2.4 percent of gross domestic product (GDP).”
The Treasury has been issuing short-term Treasury Bills. The current rate on a one-month Treasury Bill is 5.42%. Take 5.42% and subtract the 3.27% monthly interest rate on the debt and you get a cost increase of 2.15%. Multiply that by the $9.3 trillion of Treasury debt and it equals approximately $193.5 billion in additional costs. The ‘Interest on Debt (Net)’ number in the U.S. Debt Clock chart is going to increase to over $1.067 trillion. Take a look at the long red arrow in the following chart and add $193.5 billion to that number.
Source: UsDebtClock.org
But wait—sadly, it’s worse. It seems usdebtclock.org may need to speed up its algorithm. The St. Louis Fed puts the Treasury interest payments at $1.06 trillion, not $873.6 billion, as of April 25, 2024. The coming refinancing of the $9.3 trillion maturing debt, if refinanced at 5.42%, will increase the interest expense to $1.25 trillion! The interest expense cost has leaped past the defense budget in less than two years. We’ll likely surpass the cost of Social Security in another year.
If the CBO’s annual $2 trillion deficit increase is correct… you can see how this can spin (is spinning) out of control. 5.42% on $2 trillion of new debt is an additional ~ $100 billion per year (PER YEAR!) in added costs. Who’s going to want to buy the U.S. Treasury debt? Someone will, but at what interest rate? I can’t get Bruce Springsteen out of my head:
In the day, we sweat it out in the streets of a runaway American dream
At night, we ride through mansions of glory in suicide machines
Sprung from cages out on Highway 9,
Chrome-wheeled, fuel-injected
and steppin’ out over the line
Baby, this town rips the bones from your back
It’s a death trap, it’s a suicide rap
We gotta get out while we’re young
‘Cause tramps like us… baby, we were born to run
The conclusion for investors is that we’ll likely see a period of higher inflation and higher interest rates. It won’t be a straight line. Nothing ever is. We’ll have another recession—maybe sooner than we think if the inverted yield curve keeps its perfect record. Rates will move lower in a recession. Could the annual deficit exceed the CBO’s $2 trillion in the next recession? You betcha. That is not factored into the CBO’s math. Then, more sugar from the Fed and the government will lead to the next wave of inflation. At some point, a brave new leader with Paul Volcker–like conviction will emerge, and we’ll restructure the debt and entitlement mess. It will be painful, but we’ll reemerge in a better place. That sums up my current working hypothesis.
Until then, our collective investment goal is to beat inflation and preserve our wealth. I think the economy is slowing, and recession is probable, and that may lead to lower interest rates. However, it is possible that we’ll see an 8% handle on the 10-year Treasury Note within the next five years. That’s why I don’t like the buy-and-hold bond bet. The reward vs risk dynamic just isn’t there. Instead, I favor senior secured, first lean, floating interest rate private credit. Click here if you’d like to read our paper on Understanding Private Credit.
Other areas include agriculture, farmland, long-short strategies, gold, select equities, MLPs, professional sports teams, and oil and gas. While in Dallas this week, I was updated on oil and gas investments. I left excited. Please know this is not a recommendation for you to buy or sell any security. Everyone has different needs and risk tolerance.
Grab your coffee and find your favorite chair. Please simply see the data as data to take in. Try not to put emotion into it. Investing is a macroeconomic game of chess that has many moving parts. How you move your chess pieces is up to you.
Read on; we’ll take another look at the yield curve, and next week, I’ll share with you the podcast I recorded earlier this morning with Dan Steffens about oil and gas.
On My Radar:
- The Top 20 Tech Companies By Market Cap
- More on the Yield Curve and Recession
- Random Tweets
- Personal Note: High-Level Soccer at Its Best
- Trade Signals: June 20, 2024
See Important Disclosures at the bottom of this page. Reminder: This is not a recommendation to buy or sell any security. My views may change at any time. The information is for discussion purposes only.
Top 20 Tech Companies: Nearly 18% of Total Global Stock Market Value
The 20 biggest tech companies are worth over $20 trillion, or nearly 18% of the global stock market’s value. Wow!!!
This is not a recommendation to buy or sell any security. It is for educational discussion purposes only. Opinions are subject to change. Consult your advisor.
More On The Yield Curve and Recession
June 20, 2024 – Tom McClellan – “Yield Curve’s 15-Month Lag
Source: McClellan Financial Publications
“Economists got very animated in late 2022 when the Fed’s hiking of short term interest rates resulted in an inversion of the yield curve. Inversion happens when short term rates go above long term rates, which is not typically the condition rates are supposed to be showing. Most of the time, long term rates pay higher yields than short term ones, and that makes sense. If you are going to lock up your capital for a longer time, you would expect to get paid more for that.
Yield curve inversions have a perfect track record of always bringing economic recessions. And yet a lot of economists are thinking that it is different this time, and that the Fed has somehow managed to engineer either a “soft landing” for the economy, or a “no landing” scenario in which GDP never shrinks and the good times just keep rolling.
This complacency comes about via a poor general understanding about how and when yield curve inversions work. The effect of an inversion is not felt right away, but rather with a lag time of about 15 months.
This week’s chart shows the spread between the 10-year and 3-month Treasury yields. It is shifted forward by 15 months to help illustrate how GDP responds with that lag time. This yield spread first inverted on a monthly basis back in November 2022. Counting forward by 15 months takes us to February 2024, which was in the first quarter (Q1). We did not get a negative real GDP growth rate in Q1, but it did fall to a very low positive number. The full effect of the current inversion of the 10y and 3m rates has not yet been felt.
Furthermore, that economic effect should continue to be felt for a period of 15 more months after the 10y-3m spread finally disinverts. In other words, the FOMC members might believe that they are fighting current inflation right now by making current economic conditions tougher via their high interest rates. But in reality, the effect is delayed, and so the continuing inversion of the yield curve means poor GDP conditions for 15 more months after the moment when the yield curve disinverts. And we do not see any sign yet of any disinversion happening anytime soon.
If I could impose one change on our economic system, I would have the Fed outsource setting short term interest rates to the bond market. Let the 2-year T-Note yield determine the Fed Funds target rate.”
Tom uses the spread between the 10-year Treasury Note vs. the 3-month Treasury Bill. I posted the 10-year vs. 6-month spread last week, which is 23 months since inversion, tying the longest recorded period.
Not a recommendation to buy or sell any security. For discussion purposes only. Current viewpoints are subject to change.
Random Tweets
Interesting point:
Source: BLS, Haver Analytics, Appollo Chief Economist
The economy is weakening:
Source: The Daily Shot
Sharing this next tweet again this week – A record $9.3 trillion maturing over the next 12 months! Refinances at 5+%. Interest expenses to exceed defense expenses:
Source: @Kobeissiletter
I “like” and “retweet” posts I find interesting. I enjoy X because I can easily follow people I like to keep On My Radar.
You can follow me on X (formerly Twitter) @SBlumenthalCMG.
Not a recommendation to buy or sell any security. For discussion purposes only. Current viewpoints are subject to change.
Personal Note: High-Level Soccer at Its Best
I hope you are staying cool. The heat wave is on.
My wife Susan’s (Coach Sue) coaching schedule has been incredibly beneficial for my golf game. This weekend, she’s teaching a US Soccer D license course, and her high school team’s summer league has just begun. I’ll be on the sidelines with her for the next month on Tuesday and Thursday evenings, and I’m really looking forward to seeing the boys in action. With the fall season starting in August, Coach Sue will get a good first look at the new freshmen over the next few weeks and track the progress of the returning players. Since most of the boys play year-round on travel teams, their improvement from year to year is impressive.
Speaking of soccer (or football for most of the world), the UEFA European Soccer Championship has started. As I write this, the Netherlands is playing France, and it’s 0-0 at halftime. Earlier today, Austria put a beatdown on Poland, winning 3-1, and Ukraine edged out Slovakia 2-1. Yesterday, England and Denmark tied 1-1.
The Copa America 2024 tournament also kicked off last night, with Argentina beating Canada 2-0 in Atlanta. Messi!!! The US faces Bolivia on Sunday at 5 pm ET, and Brazil takes on Costa Rica on Monday evening at 6 pm ET.
This is high-level soccer at its best. Watching the games with Susan is incredibly fun. Having played in college, I thought I knew a lot about the game, but I’ve grown to realize I really don’t know that much. I’m constantly asking her, “What are you seeing?” I enjoy her so much.
Have a wonderful weekend,
Steve
“Extreme patience combined with extreme decisiveness. You may call that our investment process. Yes, it’s that simple.”
– Charlie Munger
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“The blue line in the lower section shows how much the orange line is above or below the long-term trend line. It is currently in the “Overvalued” zone. Lastly, the data boxes at the bottom of the chart display the annualized gains based on each zone (Overvalued, Fairly Valued – blue line in the middle zone, or Undervalued).”Please take note of the following text:
“The blue line in the lower section shows how much the orange line is above or below the long-term trend line. It is currently in the “Overvalued” zone. Lastly, the data boxes at the bottom of the chart display the annualized gains based on each zone (Overvalued, Fairly Valued – blue line in the middle zone, or Undervalued).”