Increased pressure on the US Treasury
The US Treasury manages the US government’s payments, and whenever there’s a shortfall in meeting expenses, the Treasury borrows and pays interest. When the tax revenue falls or the expenditure increases more than expected, the US Treasury could be forced to borrow more. Over the last 15 years, since the beginning of the “War or Terror” in 2002, government expenditure has increased because of military expenses. The situation worsened after the financial crisis in 2008. The Congressional Budget Office (or CBO), in its 2017 long-term budget outlook, pointed out that the US budget deficit could increase exponentially in the years ahead. The US Treasury could end up borrowing funds only to pay interest.
How large could deficit be this year?
The Treasury Department estimated that it could borrow $955 billion this financial year, which would be a sharp increase from the previous year’s borrowing of $519 billion. The borrowing could continue to offset the decline in revenues from tax cuts and additional spending announced in recent months. The US Treasury issues government bonds (GOVT), which are purchased by institutions, sovereign nations, and other large market participants.
Impact of increased borrowings by the US Treasury
In the last decade, lower interest rates helped the US Treasury borrow at a very low interest rate. To take advantage of the lower interest rates, the US Treasury issued more short-term (SHY)(SHV) debt with a maturity of fewer than two years. This approach could change, as US interest rates are expected to increase. Higher borrowing costs would further add to the deficit, forcing the Treasury to increase borrowing yet again. An increasing deficit doesn’t pose an immediate threat, but multiple years of an accumulated deficit would have a negative impact on bond (BND) yields and currency (UUP). In the next part of this series, we’ll further explain how the Fed faces the dual threat of rising rates and the Fed’s balance sheet unwinding program.